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Blaming OBR and fiscal stimulus

25 November 2016

 The Office of Budget Responsibility has been criticised for the downgrade in economic forecasts revealed in the Autumn Statement – is this fair?

The response to the Chancellor’s Autumn Statement would normally be split along political party lines. The papers on Thursday reflected something different; they were split according to their stance on the Brexit debate. The Remain camp still believes that the UK economy will be damaged by leaving the European Union, meanwhile those in support of the Leave campaign say that the reduced growth forecast grossly overstates the damage to the UK. The Office of Budget Responsibility (OBR) was set up as an independent agency in 2010 to stop Chancellors coming up with their own forecasts.

It has been said that “economists were invented to make meteorologists look good”. As with the weather, short-term forecasting is considerably easier than making long-term predictions. The Brexit vote has thrown a spanner in the works of economic forecasters. Is there a Hurricane heading our way? Or will it pass us by. The OBR have made some assumptions about the slowing economy due to the uncertainty around the post Brexit trading position and reduced trade in the long run. They have said “in current circumstances the uncertainty around them is even greater than it would be in normal times”.

In addition to the OBR, the Bank of England (BOE) also makes economic forecasts with bands around their central view. In the latest Quarterly report, post Brexit, they have a wider range for these bands than previously. In practice the OBR was, on balance, slightly more optimistic than the central view expressed by the BOE.

In the UK we may be worried about Brexit negotiations but as the US sits down to Thanksgiving dinner they will be worrying about what a Trump presidency means. He has already backtracked on comments in his campaign and we cannot be sure of what’s next.

As we go into the New Year we have to accept that we are in a world of heightened uncertainty which will result in big swings in sentiment. We should feel a degree of sympathy for the OBR and accept that the outcome is, like the weather, not always easy to foresee. As investors, we need to look at actual economic numbers and company news while trying to look through the political noise that surrounds us.

Is the market expecting too much from a shift to fiscal stimulus?

President-elect Trump announced in his acceptance speech that he was going to “make America great again” with massive infrastructure spending. Mario Draghi, at the European Central Bank (ECB), has indicated that the ECB is getting to the end of what it can do and it is over to governments to do their bit for the economy. In the UK, at the Conservative Party Conference, the new Chancellor indicated that George Osborne’s austerity plans would have to be watered down in light of the Brexit vote.

Increased expenditure will mean more borrowing and, if it works, higher inflation. Post the US election there has been a rotation out of bonds as inflation expectations rose and potential supply weighed on the markets. Within the equity market we have seen commodity stocks and financials out-perform consumer staples and utilities where the yield had appeared attractive relative to bonds. The question this raises is whether this is justified by what politicians actually do or will they fall short in practice?

On Wednesday, in the Chancellor’s Autumn Statement, we had the first indication of whether these policies would come to fruition. The Chancellor has increased spending and borrowing but it is difficult to see if this is anymore than a response to the expected slowdown in private sector investment as uncertainty over Brexit weighs on the economy. His actions remain constrained by the size of the deficitand the rise in long term interest rates will also be a potential constraint on economic growth.

In Europe there is little political will to make structural reforms and existing budget deficits make it difficult to increase spending without relaxing European Union rules. The Italian referendum which appears likely to reject constitutional changes is just one indication of the difficulties faced by European politicians.

In the US, what Trump will do or can do is a huge uncertainty. In theory, a Republican President with a Republican Congress should have a better chance of pushing through his agenda. Unfortunately, his agenda is not at all clear and the fall in bonds is already pushing mortgage rates higher. A wish to balance budgets in Congress may yet constrain his wishes.

Maybe something did change with Trump but the Autumn Statement was less than overwhelming and at the moment we are seeing very little evidence of a real shift in policy in Europe. Considering the high debt levels and low unemployment in the US and UK, we remain to be convinced that reality can live up to the raised expectations.


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