Sajid Javid’s resignation as Chancellor of the Exchequer last week triggered a rally in sterling, as markets began to speculate that his departure suggested an increased likelihood of fiscal stimulus from Boris Johnson’s government.
This reasoning may seem stretched, but viewed in the light of the reported circumstances of Javid’s departure, the sterling rally makes some sense. Javid reportedly resigned after Boris Johnson demanded he replace his team of advisors with appointments made by himself.
A treasury official reportedly commented that Sajid Javid said “no self-respecting minister would accept” the terms he was offered to stay.
Chart: Javid resignation triggers sterling rally
The prospect of direct No 10 control of fiscal policy seems to have been taken by markets as an indication the Government is planning a deficit funded increase in spending. Such an increase would raise prospects for growth and inflation, and reduce the chances of a rate cut from the Bank of England.
This prospect has raised the stakes of March’s budget significantly for UK markets, especially sterling.
For now, markets may be happy pricing in a Trumpian spending spree, but in truth the Government’s fiscal plans remain unknown. The most recent OBR forecasts implied that spending commitments could be raised by around 1% of GDP at March’s budget, while still adhering to the Treasury’s goal for a balanced budget within three years.
Given the Bank of England’s recent downgrades to medium term growth forecasts, there is a high likelihood that the OBR will revise down its estimate of fiscal headroom, leaving deficit spending as the only option for increasing stimulus.
Friday’s PMI figures will shed further light on the state of the economy that new Chancellor Rishi Sunkak will inherit. After a poor fourth quarter of 2019, Last month’s PMI figures indicated a robust bounce-back in business sentiment and reported output growth.
This improvement partly vindicated the Bank of England’s recent decision to hold fire on interest rate cuts.
The final composite PMI reading was 53.3, consistent with quarterly GDP growth of about 0.2% in Q1. Anecdotal reports accompanying the release made it clear that falling political uncertainty had driven much of the improvement in sentiment.
Chart: January PMI bounce suggests improvement in growth outlook
Businesses have received more information about the UK’s plans for trade relations with the EU since then, in the form of major policy speeches from Boris Johnson and Michel Barnier.
February’s anecdotes will be interesting as a gauge of businesses’ reaction to the emerging picture of EU-UK trade talks, as well as a good indication of how much of an investment pickup can be expected in Q1.
Author: Ranko Berich, Head of Market Analysis at Monex Canada.