Brexit gilt trip

The UK gilt market appears now to discount a more expansionary budget to be delivered by the new chancellor, potentially setting up tensions around the EU’s negotiating strategy and even around the setting of UK monetary policy.

Key points

• The surprise resignation yesterday of UK Chancellor (Finance Minister) Sajid Javid may in hindsight have been the almost inevitable culmination of growing tensions between No. 10 and No. 11 Downing Street. But it marks a potentially material change in fiscal policy
• The UK gilt market responded to the news with a modest jump in yields consistent with an expectation of greater issuance, in turn suggesting a greater degree of fiscal easing from new chancellor Rishi Sunak compared to expectations under Sajid Javid
• Any such shift would excite yet more contemplation of where lies the centre of gravity in policy-making in key areas of the UK economy. On 29 January 2020 the Financial Times reported that Sajid Javid, supported by PM Johnson, had “(ordered) budget cuts of at least 5%” from all spending departments. On 5 February 2020 the FT was reporting that Dominic Cummings had “wanted (Javid) to announce lots of new spending and lots of tax cuts” likely informed by concerns to keep faith with voters in formerly Labour heartlands who PM Johnson acknowledged as having ‘lent’ him their vote in securing his dramatic majority
• Any more expansionary fiscal policy could also have the effect of inuring to some degree the UK economy in 2021 against any disturbances from the scheduled ending of the Transition Period at the end of this year. But it could also colour the EU’s negotiating strategy for any trade deal if it (or member states) felt that the UK was seeking unfair advantage through such fiscal easing (Singapore-on-Thames)
• The resolution between those two very different fiscal policies, prudence versus greater fiscal expansion, will be revealed in Sunak’s first budget – still slated for 11 March although there is some speculation the date may have to shift if he wants to deliver something more expansionary than Javid’s framework

What to watch in coming days/ weeks

While we wait for the next budget we’ll keep an eye on a few canaries for any early warning signs of a change in expected fiscal policy:

• Gilt yields – if they maintain the recent rise or go higher still it will suggest a more expansionary budget of higher spending plans and tax cuts
• Budget date – if that is moved beyond the currently scheduled 11 March that is likely to be interpreted as being necessary to accommodate material changes to former chancellor Javid’s proto-budget
• Bank of England (BoE) Monetary Policy Committee (MPC)
  • The next MPC meeting is not until 26 March which is likely still to be after Sunak’s first budget even if he does move the date from 11 March
  • Seasoned central-bank-watchers in financial markets will be paying close attention to the words of MPC members ahead of their next meeting. At the last meeting (29 January) they were split 7-2 as between ‘hold’ or ‘CUT’ interest rates
  • If Sunak’s budget is deemed ‘too expansionary’ that vote could easily switch to 7-2 as between ‘hold’ or ‘HIKE’
  • In the world of central-bank-watching such a change in nuance can represent a big shift in the bias of monetary policy as perceived by financial markets and could cause sterling to spike higher still
  • Monetary tightening to offset some effects of fiscal expansion may not suit everyone in and around government. Indeed new governor and former FCA chair Andrew Bailey was moved to warn politicians “not to meddle with (BoE) independence” as far back as August 2019.