On what is another relatively quiet summer’s day in financial markets, the only thing that stands out is the increasing rhetoric over the use of fiscal policy; either in conjunction with, or as a substitute for rapidly diminishing monetary policy options.
The Bank of England stands out as a classic case. Faced with a Brexit scenario, the BoE’s response has been to slice interest rates to a record low 0.25% and expand its quantitative easing programme by £60bn worth of gilts and £10bn of corporate bonds. The decision was thought to be more pre-emptive than reactive (although a meeting later than what was initially suggested), and economic data releases since, although too early to tell, have surprised on the upside.
Brexit will no doubt negatively impact the UK economy, no-one knows quite how badly or how long this will last. It is therefore imperative that policymakers ensure they understand the complexities of the situation before following in the footsteps of the BoJ and ECB; who in effect continue to print money and slip deeper into negative rate territory in the hope to stimulate growth and pull inflation up from close to negative levels. Looking at the economic data, this option is clearly not working. With BoE Governor Carney insisting that he is ‘not a fan’ of negative interest rates and that other central banks living with sub-zero rates got it ‘a bit wrong’, we ask what other options are available.
Slashing interest rates worked relatively well during the financial crisis, where huge amounts of debt was the issue; from households, to corporations, and even sovereign debt. Lower interest rates then meant fewer defaults, saving banks and thus the broader global economy; whether that was the best option, or whether those in control should have let certain large defaults happen is a discussion for another day. Now policymakers are faced with next to no economic growth globally, therefore a different recipe is required.
The obvious concoction, would be for the UK government to complement BoE monetary policy with a bout of well targeted fiscal spending in the public sector and possibly a cut in corporation tax. According to the ONS, infrastructure spending has fallen sharply since the UK voted out. However, PM Theresa May has pledged to boost infrastructure spending and launch infrastructure bonds. In fact according to news reports today, May and Chancellor Hammond could be looking to borrow as much as £50bn in the next financial year to splash out on infrastructure spending, benefitting from record low borrowing rates; a win-win scenario!
Meanwhile, with China’s fiscal deficit running relatively small compared with other major economies, we heard that the PBoC is looking to increase the deficit from 3% to 5% to stimulate growth. Sheng Songcheng, an analyst at the central bank noted that although interest rate cuts and tax cuts can help spur growth, ‘Falling interest rates, even negative rates, may not encourage investment’, and that a cut in corporation tax ‘is an urgent policy and a policy we need to actively implement now’. With an availability of policy firepower, China has the room and scope to manage growth, the same however cannot be said for the other big banks.