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Fund manager view: Hammond’s hardly top gear

Written by: Richard Buxton
The reaction of financial markets to the new Chancellor’s first, and last, Autumn Statement pretty much says it all; big surprises were conspicuously absent, but longer-term challenges remain.
Fund manager view: Hammond’s hardly top gear

It is, arguably, possible to have too much excitement in life, and so for some of us at least, the relatively sober nature of the 2016 Autumn Statement will have come as welcome relief amid an evolving macroeconomic and political backdrop that has kept market-watchers and political pundits alike on their toes for much of the year.

The chancellor was of course keen to point to IMF forecasts showing that the UK remains on track to be the world’s fastest-growing major economy, referring to the economy’s fundamental strength, global reach and successes in the fields of science and technology.

But his introductory remarks also quickly turned to the UK’s well-documented productivity gap, challenges in the housing market and regional disparities.

So, what is he going to do about it? The simple answer is that there will be a bit more spending linked to improving productivity, but then this was widely anticipated.

The devil, I believe, is in the detail of the macroeconomic assumptions on which Mr Hammond’s plan is based. The Office for Budgetary Responsibility (OBR) now expects annual GDP growth from 2017 to 2021 to be 1.4%, 1.7%, 2.1%, 2.1% and 2.0% respectively, while the 2016 forecast is 2.1%. I suspect this is somewhat above consensus, and the government’s critics will point out that it is weaker than the March forecast.

Borrowing is predicted to be higher in every year due to weaker tax receipts, lower economic growth and higher public spending. According to the forecasts, debt will be £32 billion higher in 2021 peaking at 90% of GDP in 2017/18 due to higher borrowing, lower asset sales and the operations of the Bank of England. The increase in borrowing will rise to £122 billion over the Parliament ending in 2020. There is still set to be a period of fiscal tightening (at just under 1% of GDP per year for the next three years), but new rules give some room to manoeuvre should the economy prove weaker than expected.

Notwithstanding a brief tribute to his predecessor’s fiscal prudence, Hammond conceded that the government will now attempt to return public finances to a deficit of 2% of GDP in this Parliament, and eliminate it “as soon as possible” in the next Parliament.

My reading of the OBR’s GDP growth forecasts is that the government’s ‘spending watchdog’ expects sentiment – in the broadest sense – to be more buoyant in the second half of 2017 once Article 50 has been triggered. The question is, why would growth slow so much in 2017, then inexplicably pick up in subsequent years?

On the basis of the OBR’s figures, the government’s plan is to reduce the UK’s budget deficit to 2% of GDP by 2020. The key challenge to achieving this ambition will be if economic growth turns out to be lower than forecast.

In my view, substantial risks to the UK’s economy remain, bringing into question an implicit suggestion that animal spirits will suddenly rise in the years ahead. As it stands, the country continues to face the same uncertainties that triggered such a sharp decline in the value of sterling in the aftermath of the EU referendum vote.

Should economic growth indeed disappoint relative to the OBR’s forecasts, it is of course inevitable that the budget deficit will fail to come down as quickly as hoped, which in turn hardly paints a rosy picture of the outlook for sterling.

The response of financial markets to the Statement was muted: gilt yields, reflecting the cost for HM government to borrow money, rose modestly, although in practice this only mirrored similar moves in the US and Europe. Similarly, modest declines in the stock market largely reflected comparable shifts in continental Europe and North America. While the pound declined by about 0.5% versus the US dollar, it actually rose versus the euro.

These figures hardly have the makings of big headlines, but anyone who was hoping for more ambitious fiscal stimulus plans is likely to finish the day feeling just a little disappointed. Time will tell whether the OBR’s forecasts do indeed turn out to be overoptimistic, but in the meantime Hammond’s speech, while delivered with good humour, did little to set my pulse…racing.

Richard Buxton is head of UK equities at Old Mutual Global Investors

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