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Spending review merely confirms emergency budget, says Newton’s Hensman

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Peter Hensman, global strategist at Newton Investment Management, says Wednesday’s spending review merely confirmed the initial plans laid out in June’s emergency budget and the market reaction has therefore been negligible with sterling and gilts barely shifting.

“This is little more than a ‘thumbs-up’ from markets, suggesting that the nature and size of the planned austerity measures had already been priced in. A lack of surprises was just was the market wanted,” he says. 

Earlier this year there was genuine concern from financial markets that the UK economy might be in the same precarious position as many of the peripheral Eurozone states, highlighted by Greece’s well publicised travails. Ten-year UK gilt yields, which in March 2009 were at the same level as ten-year German bunds, were yielding one per cent above their German equivalents by the end of February this year. 

According to Hensman, Labour’s defeat in the UK general election, the subsequent formation of a Conservative/Lib Dem coalition government and its promise to cut the UK’s fiscal deficit within five years restored a degree of confidence in the economy. Since May this year, gilt spreads over bunds have narrowed by around 30 basis points. 

“However, while its austerity measures have gained credibility within financial markets, and support from the International Monetary Fund and a number of high profile business leaders, backing for the Coalition’s action is by no means universal,” Hensman says. “There continues to be widespread concern that these measures are too much, too soon. It’s clear that the UK economy is by no means out of the woods yet, and that the risks facing both the economy and government finances remain high.” 

Hensman believes these measures will impact upon the UK on both an economic and social level for years to come. The weak start point means that the economy and fiscal position is likely to remain very susceptible to any shortfall in growth. In effect, the coalition is relying on the Conservatives’ early 1990s approach to driving economic recovery, but the current backdrop is starkly different.

“Elsewhere, while the drop in gilt yields seen this year has meant a reduction in the cost of servicing the UK’s debt, this money has already been spent in the government’s plans – a risky ploy given that the fall in gilt yields has owed considerably more to global conditions than factors specific to the UK. There was certainly more than a hint of ‘party politics’ in Osborne’s speech,” Hensman adds. 

Meanwhile, there has been a shift in the stance of central bankers towards further monetary stimulus in recent times. Hensman says the Bank of England already seems to be considering further quantitative easing – Monetary Policy Committee member Adam Posen voted for a further GBP50bn at the MPC’s October meeting.

“Tighter fiscal policy tends to contribute to a looser monetary stance, and this is likely to be the case while the economy undergoes the planned austerity in the public sector. As such, further QE seems likely over the coming months. 

“Are the Coalition’s cuts too much, too soon? I don’t think so,” says Hensman. “Clearly some parts of the economy will suffer more than others, but we are already seeing improvements in financial markets, especially corporate bonds, and that should remain supportive of private sector activity. A double-dip recession can’t be ruled out, but it seems increasingly unlikely in an environment in which businesses are able to finance themselves on attractive terms."

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