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Coalition pins hopes on private sector to lead UK’s recovery

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Peter Hensman, global strategist at Newton Investment Management, says the Conservative/Lib Dem coalition takes the view that it is the private sector which will lead the UK’s economic recovery.

The problems caused by overspending will be resolved not by throwing money at the problem, but by reigning in some of the excesses, he says.

“So, the coalition believes that by reducing the excessive spending in the public sector, it will allow greater space for private demand. Furthermore, with feverish markets focused on the unhealthy state of government finances, a failure to tackle the high levels of public sector indebtedness would result in a funding crisis and cause an even larger negative impact on demand,” says Hensman.
 
He believes growth and underlying inflation (excluding the impact of the VAT increase) are likely to be subdued for the next few years as these austerity measures are implemented.

However, an economy undergoing this kind of sharp adjustment is likely to be more susceptible to market whims and the knock-on effects of external shocks.

“That said, as Mervyn King, the Bank of England chairman, highlighted in his Mansion House address last week, ‘if prospects for growth were to weaken, the outlook for inflation would probably be lower and monetary policy could then respond’ – so there is scope for monetary policy to lend a helping hand if necessary,” adds Hensman. 
 
The initial reaction to the Chancellor’s budget speech from sterling and the gilt market has been one of cautious optimism.

“The headlines over the past six months have been dominated by sovereign credit risk concerns and, in particular, fears about the sustainability of sovereign debt levels in the periphery of Europe,” says Hensman. “Arguably the biggest risk was that the budget speech would fail to deliver on the expected levels of austerity, and that the UK would therefore move closer to being included in the same breath as the likes of Greece, Portugal and Spain, where their ability to service their debt and retain investor confidence is in constant doubt.”

Should the coalition government be able to deliver on its projected fiscal austerity, then this should continue to provide support to both sterling and the gilt market, adds Hensman.

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