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Budget noise and the real drivers of economic growth

While the Autumn Budget gets plenty of attention, its impact on the economy is overstated.

4 January 2018

12:47 PM

4 January 2018

12:47 PM

Ah, the Budget. The business world and financial media’s favourite annual event garners so much attention, you’d be forgiven for thinking Chancellor Philip Hammond was Santa and that red briefcase his bag of toys. Who was naughty? Who was nice? Who will get goodies, and who lumps of coal? Whether fearful or cheerful, headlines regularly tout the Budget’s supposed economic importance. This time around, some have called it a Suez moment for the UK economy, while others claim it might boost growth in certain areas. But regardless of their opinion, pundits tend to overstate the importance of the Budget to the economy. In a private sector-led economy, fiscal policy may pick winners and losers, but it generally doesn’t drive growth.

Most Budget provisions are small and targeted, aimed at niche problems that politicians want to be seen to be fixing. For instance, one of the Autumn 2017 Budget’s flagship measures was a stamp-duty cut for certain first-time home buyers. Though it grabbed headlines, it is likely to have had little or no impact on economic growth. How come? The new policy would more than double the stamp-duty threshold to £300,000 for first-time buyers, exempting properties up to that amount from tax. Additionally, for properties worth £500,000 or less, the first £300,000 would be duty-free (up from £125,000). While analysts expect this to save 80 per cent of buyers about £5,000, the Office for Budget Responsibility estimates it will drive property prices 0.3 per cent higher, largely cancelling out the intended benefit. Even if it spurs some buyers to action, residential property accounts for only 3.1 per cent of the UK economy.[i] For years, the government has tried various other ways to subsidise home demand. None of them added much oomph to the economy or improved home affordability in crowded, high-priced London, which happens also to be the focal point of the nation’s housing shortage. This is a supply issue, not a demand issue. To that end, while the government also pledged £15.3 billion to increase housing stock over the next five years and introduced planning reforms aimed at making more land is available for housing, construction makes up only 7.5 per cent of UK GDP[ii].

Another widely discussed measure, the one setting aside £3 billion for Brexit, lacks the scale to affect growth in any material way. The government says money is necessary to tackle administrative issues like preparing for the introduction of EU border controls in the event that it fails to agree a special trade deal before Brexit takes effect – which will require more customs checkpoints, staff and banal things like lorry parks. Whether or not this contingency planning is necessary in the end, £3 billion is just a tiny fraction (0.16 per cent) of the £1.9 trillion UK economy and isn’t likely to spur growth.

Free markets grow bottom-up, not top-down – private sector economic fundamentals and credit conditions matter more than which smattering of winners and losers the Chancellor pulls from that red briefcase every year. On that front, economic fundamentals have held up better than the doom and gloom many expected after the Brexit vote. Moreover, IHS Markit’s purchasing managers’ indexes for services and manufacturing have picked up in recent months, with businesses reporting strong new growth. Meanwhile, credit conditions remain healthy. The yield curve – the difference between short and long-term interest rates – is positively sloped. That’s good for banks’ loan profits, as banks borrow short-term and lend long. As a result, that positively sloped yield curve should also encourage loan growth, which accelerated to 4.2 per cent year-on-year in October[iii]. The acceleration came from business lending, which rose 3.6 per cent year-on-year in October – a sharp increase from September’s 2.9 per cent[iv]. Broad M4 money supply is also growing at a healthy clip, up 4.2 per cent year-on-year in October [v]. Overall, the UK economy has plenty of fuel.

The Conference Board’s Leading Economic Index for the UK (LEI) suggests further growth. While this index has ticked downward in recent months, wiggles in the data series are normal. The recent decline doesn’t necessarily mean trouble ahead. False reads during expansions often happen, as the graph in Exhibit 1 shows. Whenever LEI declines, it is important to look at its components and see what is driving the pullback – not all components are equally forward-looking. The UK’s LEI decline stems mostly from consumer sentiment and expected home sales – both based on surveys rather than airtight leading indicators. Consumer sentiment often doesn’t match behaviour. Sentiment surveys capture how respondents feel, not necessarily what they do. Media influences sentiment heavily, and all UK consumers have heard for months is that rising inflation will squeeze households and quash spending. That will depress sentiment whether or not it eventually comes true – and so far this year, it hasn’t. The yield-curve spread is the most forward-looking component, and it continues contributing positively. Other forward-looking gauges that aren’t in LEI, like services and manufacturing new orders, are also rising.

Exhibit 1: UK Leading Economic Index

Source: The Conference Board data from 31/3/1970 through 30/9/2017 as of 8/12/2017

Source: The Conference Board data from 31/3/1970 through 30/9/2017 as of 8/12/2017

Overall, the private sector appears poised to continue to power the UK economy forward, irrespective of Budget noise.

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This document constitutes the general views of Fisher Investments UK and Fisher Investments, and should not be regarded as personalised investment or tax advice or as a representation of their performance or that of their clients. No assurances are made that they will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts may be, as accurate as any contained herein.

[i] Source: Office of National Statistics, Second Estimate of Q3 2017 GDP and Business Investment in the UK : July to September 2017 provisional results.
[ii] Ibid. Second Estimate of Q3 2017 GDP and October 2017 Construction Output in Great Britain, October 2017.
[iii] Source: Bank of England, as of 6/12/2017. M4 Lending excluding intermediate OFCs, October 2017.
[iv] Ibid. M4 Lending (ex. intermediate OFCs) to private nonfinancial corporations, September and October 2017.
[v] Ibid. M4 ex. intermediate OFCs, October 2017.

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