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Stimulating Thoughts

30 November 2020

Quite why so much airtime is afforded the output of the Office for Budgetary Responsibility is beyond me. Its record is, quite frankly, abysmal and yet the Chancellor is bound by its forecasts when he sets his abacus to work. This time around the margins for error are enormous – even more so than usual. Over just four months the OBR has revised its forecast for the unemployment peak up to 11.9% and down to 7.5% and there seems every likelihood it will march the figure back up again in the New Year. I fail to see what use such figures are to anybody. I won’t waste my time or yours highlighting the rest of the OBR’s figures. Life is too short.

We all know the state has had to borrow on a massive scale to fund the Covid protections with the intention of saving as much of the economy as possible. At least with interest rates so low and likely to remain that way for some years there is no immediate pressure to tackle the debt. The best way to do so is to stimulate the economy as much as possible. Firstly the debt becomes smaller as a percentage of the economy and secondly the increased tax revenues allow some of the debt to be paid down. The worst way to tackle it is to raise taxes. That will stifle economic growth at best and shrink it at worst. Tax revenues turn out to be less than expected and the debt increases as a percentage of the shrunken economy. It is the worst of all worlds.

Hopefully, Mr Sunak will choose the former route although he is cutting some government spending by way of a wage freeze on public sector workers outside of the NHS. Whether one agrees with that or not he needs to put that money to work elsewhere, as he does with the funds clawed back from the Aid budget. But whilst the state’s borrowings have gone through the roof the same cannot be said for individual finances. In fact, household savings have been rising strongly throughout the pandemic, not only here but in the US and many other countries too. The potential for a consumer spending binge is building consistently each quarter and although it might take a rest for Christmas I would not be surprised to see it building again in the New Year. At some point next year, probably governed by the timing and success of the vaccine roll-outs, that pent-up urge to spend is going to be unleashed. From what is becoming more of a W economic formation the final escape thrust could be far stronger than most are envisaging.

Such a spending rush could begin to push inflation up but the inclination is likely to be for governments to let their economies run hot, at least for a while. For yet another way to tackle high state borrowing is to inflate it away. The developed world has been trying to create some inflation for a number of years with minimal success so the opportunity to actually have some and allow it to rise in a controlled fashion might be looked upon quite favourably. So, stimuli first, a bit of inflation second – higher taxes and interest rates can wait until the economy is rolling along healthily. Hopefully the Chancellor will have similar thoughts.

Market Thoughts

Assuming something along the above lines evolves and, granted, it is quite an assumption, the stock market will have the scent of it well in advance. It will also anticipate the longer-term ramifications of the end of a period of next to no inflation and declining interest rates. Governments may let inflation rise for a while but at some point they will have to act and interest rates will need to finally begin rising. That will mark the end of the long benign period for bond investment. The potential for higher inflation and interest rates, even if the latter is a little further out, is likely to see a sizeable movement of cash from bonds to equities.

So although the early part of 2021 may still be full of uncertainty, once the Covid vaccines are being dispensed equity markets might be much more positive. Bear in mind also our recent suggestion that, should a Brexit deal of some sort finally be agreed, there appears to be a wall of predatory money looking at the UK market whilst it sits at such a discount to other majors. Perhaps it won’t all end in Tiers after all.