Brexit – the reset button

by | Sep 13, 2016

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IFA Magazine’s Editor-in-Chief, Michael Wilson, takes a candid look at what might lie ahead for Chancellor Hammond and the monetary authorities in the aftermath of the vote to leave the EU, one of the most significant events in UK economic history for a generation.

For advisers, looking ahead and helping clients to plan their financial future is proving to be rather more tricky these days with all the imponderables resulting from the Brexit decision. So what might Mr Hammond’s reset look like? 

It was, I think, Winston Churchill who observed that democracy was the worst possible form of government apart from every other system that had ever been tried. And so now, more than two months after the shock news about the 23rd June referendum came in, we’re slowly coming to terms with the three most depressing things that we’ve learned this year.

 
 

Firstly, that it’s possible for a politician to lie to the public openly, and successfully, if he thinks that the underlying mood is right; secondly, that telling the electorate to ignore an overwhelming body of expert opinion is not necessarily going to alarm them if they’re feeling angry enough about other things; and thirdly, that we’re stuck with the result of what was plainly a deliberately bent referendum campaign. If you can fool enough of the people for a few precious weeks, their democratic decision stands.

And nor all thy piety nor your wit shall lure them back to cancel half a vote, nor all thy tears wash out a word of Article 50. The people have spoken, and it doesn’t help now to protest that they don’t seem to understand very much.

Poker faces in Europe

To be sure, Britain’s EU partners aren’t showing their cards yet. Behind that blank refusal to talk to Britain until Article 50 has been activated and the Brexit fuse has been formally lit, there lies an eagerness to find the most accommodating arrangement for moving to the next stage: Frau Merkel would be cutting off her own nose to spite her face if she sent a major player like Britain out into the freezing cold. But at the time of writing there was still no real hint that Theresa May could ever get a sniff of the Single Market, or of the European Banking Passport, unless we also signed up to the complete European package on freedom of movement.

 
 

Okay, that’s not what Boris Johnson, the Foreign Secretary, is saying. He told a US gathering in July that Britain would have no problem with getting the banking passport without the single market obligations. It was, admittedly, a surprise to find Mr Johnson back in the Cabinet so soon after having engineered the June catastrophe, but presumably he’s been given one last chance and told not to blow it this time.

A farewell to austerity

One former Cabinet member who didn’t get a second chance (despite asking, apparently) was George Osborne, who had made a public mantra out of austerity during his six years as Chancellor but who had never quite managed to transfer the pain from the private to the central government sector. Having postponed the scheduled date for balancing the budget from 2017 (check) to 2018, 2019 and then 2020, his personal currency was wearing thin long before the June referendum.

There was also, of course, the fact that his public school face didn’t fit Theresa May’s boldly meritocratic government any more than David Cameron’s would have done. But more important is the fact that Mrs May has opted to junk the austerity message altogether, in favour of what some might call a Keynesian expansion programme and the rest of us would probably call a bit of blessed relief.

 
 

The fact that the financial markets have been well and truly rattled by the prospect of more debt, lower bond yields and a less attractive currency is almost beside the point. The plunge in sterling’s value has been one thing: the barely-concealed threats by international companies to move their operations back into Euroland is another. Even if George had been invited to stay at the Treasury, it’s almost impossible to see him enjoying the challenge of reversing his own trademark policy.

“Spreadsheet Phil”

But that, of course, was not to be. If Theresa May (sober, well organised, ex Bank of England and, perhaps crucially, educated at Wheatley Park Comprehensive) was gunning for the Bullingdon Club set, she was more likely to find a soul-mate in “reassuringly boring” Philip Hammond (Transport Secretary, Defence Secretary, then Foreign Secretary – and, just as crucially, state-educated in Brentford).

Hammond got his first top-table break in 2010 when the then Defence Secretary Liam Fox got caught advancing sensitive security clearances to a personal advisor and had to resign in a hurry. Hammond inherited a tough brief – including having to implement savage defence staffing cuts – but he managed to do it smoothly and without causing unnecessary rancour. As Foreign Secretary he gained a reputation for being methodical, undramatic and unusually well-briefed – learn by example, Boris Johnson! – and his Whitehall nickname “Spreadsheet Phil” will have done him no harm along the way.

That reset business

What exactly is Mr Hammond’s economic reset going to mean? For the first time, we can reveal the searing truth to our readers. We have no idea. But I’d be surprised if we don’t see one of the biggest interim Budgets sometime soon that this country has seen in half a century.

  • Bank rates: One thing we can say for sure, obviously, is that fiscal stimulus will be the watchword, and that austerity will be out of the window. Bank of England governor Mark Carney has already dropped the base rate and hinted that he may be prepared to go further in a move to stimulate both investment and consumption. No, don’t ask how much lower than 0.25% a base rate can go, because you wouldn’t like the answer. But Japan and several EU countries have already felt the burn of being ultra-cool.How, exactly? Quite literally, by sending base rates below zero so that instead of getting interest on their overnight lending to the Bank of England, banks actually have to pay the BoE for looking after their money. That may well ripple out to business bank customers, who may very well find themselves paying their banks in the same way: Natwest and RBS have already written to their customers about it.
  • The impact on foreign markets: That, of course, is not such bad news as it sounds, because it encourages business to spend their cash rather than hoarding it. It’s also lowering mortgage rates even now. But the worry is that the fall will also feed through to tighter bond yields – part of the reason why sterling has become so very unattractive to foreigners recently. And this despite the fact that London-registered equities have done better than their Eurozone counterparts since the Brexit vote.What could a weaker pound mean? Easier and more profitable exports, we’d assume. But we might be assuming too much there. Until we’ve seen how Brussels decides to play the EU trade-bloc game, and how a possible President Trump reacts to a dollar-undercutting pound, we won’t be throwing our hats into the air in jubilation.
  • Support for foreign investment: At a time when not just international corporations but even banks and financial institutions are reported to be commissioning relocation studies, Chancellor Hammond will be looking for ways to sweet-talk them into remaining. How’s he going to afford that?
  • Quantitative Easing is one obvious possibility, and many believe that it’s the most likely candidate at the moment. Mr Carney hinted as much in late June, as the Brexit shock waves were still reverberating, because he said the pace of economic growth was “materially slowing”. And there’s no reason to suppose that things have improved since then: indeed, the final PMI confidence survey statistics for June showed the worst drop since the 2008 global economic crisis.We’ve seen QE before, of course. Between 2009 and 2012 the BoE ‘created’ £375 billion that wasn’t there before, by buying in government bonds so as to get money flowing through the economy again. But QE isn’t a magic bullet. It certainly didn’t work as well for George Osborne as it did for the Americans, who saw their own economy bounce back far more strongly in response to QE; and there are many who doubt that QE has done Japan any favours either.Does QE weaken a currency by increasing debt levels? It didn’t seem to do that for the Americans, although admittedly they have the might that can make things right, and we might turn out to be a different case. What it will certainly do is elevate inflation levels and ward off the spectre of deflation which Osborne spent so many years trying to head off.
  • Regional incentives: No new government that was half serious about reuniting the nation would dare to ignore the provincial resentment that the referendum revealed about their contemporaries within the affluent M25 “bubble economy”. And it would be simply astonishing if Chancellor Hammond didn’t reboot Mr Osborne’s jaded ideas about restoring the provincial balance with some proper regional incentives and a relaxation of budgetary constraints. Yes, it’ll cost our grandchildren to rectify the overspend, but needs must.
  • Tax: Apart from a redoubling of the HMRC campaign against evasion and/or aggressive avoidance, there will be little incentive for Chancellor Hammond to pile further grief on a nation that’s still in shock. Will he try to claw back the incentives handed out to the elderly or to pension savers? It seems awfully unlikely. Will he press ahead with Osborne’s help for house buyers? Again, it seems like the wrong moment to be changing horses. Better, surely, to plough ahead with consumer-led giveaways. It didn’t do Chancellor Nigel Lawson much harm in the 1980s.

And so back to Europe

Which is where we came in. All options are wide open at the moment – but unfortunately the Chancellor’s parameters for freedom are likely to be defined at least in part by Theresa May’s success in getting an honourable exit from the EU, instead of the dishonourable discharge that some of the angrier members are muttering about. Can we retain our dominance in financial services? Can we incentivise international businesses without breaking EU competition rules? I suspect we are about to find out.

 

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