- Infrastructure spending plans underwhelm economists
- FX strategists say plans unlikely to shift dial for Sterling
- Sterling enters July unloved by FX markets
30/06/2020. Dudley , United Kingdom. Boris Johnson Economic Recovery Speech. The Prime Minister Boris Johnson delivering his speech at Dudley College of Technology on the economic recovery process from Covid-19. Picture by Andrew Parsons / No 10 Downing Street
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A highly anticipated announcement on how the Government intends to spend the economy out of its coronacrisis slump left foreign exchange markets distinctly underwhelmed, ensuring the British Pound's ongoing trend of devaluation remains intact.
Sure, the Pound did jump on June 30 but as we note here this was almost certainly a technical move driven by month-end flows, rebalancing and options expiries and not due to any fundamental shift in the drivers of the UK currency. "The FX market was largely driven by month- and quarter-end flows yesterday. These boosted CAD and GBP. The EUR/GBP cross was a particularly big mover," says Marshall Gittler, Head of Investment Research at BDSwiss Group.
Heading into July Sterling remains a bottom-dweller in global foreign exchange markets as it has now lost ground against all its G10 peers apart, from the Norwegian Krone, in 2020.
What we know is that renewed Brexit anxiety and ultra-loose monetary policy at the Bank of England are two factors behind the losses, but one potential ticket to support would be a sizeable boost to fiscal spending by the Government, that would give a kick to the economy and help it recover from the crisis.
All eyes were on Prime Minister Boris Johnson's 'new deal' announcement on Tuesday, where any surprises had the potential to lift Sterling from its quagmire. In the event, it was announced that £5BN - or 0.2% of GDP - of spending on infrastructure projects would be brought forward into 2020.
The reaction by FX markets suggests markets were ultimately disappointed with analysts pointing out that only new announcements of additional spending would likely have had the ability to shift the dial on Sterling.
Ruth Gregory, Senior UK Economist at Capital Economics described the announcement as "fairly underwhelming and is unlikely to do much to help the hardest-hit parts of the economy over the coming months".
"Prime minister Boris Johnson’s speech does not alter much GBP prospects as (a) the infrastructure" spending was expected, as was outlined in the March budget, (b) the UK-EU trade negotiations remain the key driving factor behind GBP," says Petr Krpata, Chief EMEA FX and IR Strategist at ING Bank.
The Pound-to-Euro exchange rate is quoted at 1.1018 in the wake of Johnson's spending announcements while the Pound-to-Dollar exchange rate is at 1.2365..
The basic economic theory goes that by increasing spending the government has an opportunity to stimulate economic activity and create jobs and in doing so help speed the recovery from the coronacrisis. Johnson's spending plans came on the day the ONS reported the economy shrank 2.2% quarter on quarter in the first quarter of 2020, which was the joint largest fall since 1979 and sets the stage for an unprecedented fall in the second quarter when the full impact of the lockdown hit.
Another problem for the government, and by extension Sterling, is that even large fiscal boosts such as infrastructure spending take time to feed through to the economy.
"The government is prepared to live with a higher level of debt and will continue to prioritise supporting the recovery in the coming years. While progress in Brexit talks and looser fiscal policy would be supportive for the Pound, they are not immediate triggers for a rebound," says Derek Halpenny, Head of Research, Global Markets EMEA and Head of International Securities at MUFG.
Gregory points out that the UK government - regardless of the party in power - has a history of underdelivering on investment, pointing out that between 1999 and 2016, for example, investment spending undershot the plans made in the prior year by 12% on average.
Johnson nevertheless vowed to "build, build, build" to soften the economic impact of coronavirus:
- £1.5bn - hospital maintenance
- £100m - 29 road network projects
- £900m – ‘shovel ready’ local projects in England for 2020/2021
- £500,000- £1m for improvements to parks, high street and transport
- >£1bn - schools building projects
- £83m for prison maintenance and young offender facilities + £60m for temporary prison places.
We await an announcement by Chancellor of the Exchequer Rishi Sunak next week for details on where the building will take place and what projects will receive the money, and indeed whether there are any new initiatives at all.
"Admittedly, there wasn’t much for markets to get excited about in Johnson’s latest speech. Tuesday's £5bn pledge makes up only a small portion of the planned increase in annual public net investment from 2% to 3% of GDP outlined in the March budget. And as always with such infrastructure-related pledges, the challenge will be to identify projects that are not only ’shovel-ready’, but that are productivity-enhancing too," says James Smith, Developed Markets Economist at ING.
But based on the lack of a real spending increase, the Pound is left unloved and prone to further downside as the familiar topics of ultra-loose monetary policy at the Bank of England and Brexit trade negotiations maintain their hold on the narrative.
"EUR/GBP broke through our quarter-end target of 0.91. We see more downside to sterling and expect EUR/GBP to trade above 0.92 this summer. As UK-EU negotiations are unlikely to progress, more risk premium can be priced into GBP. We also note the structural change in GBP sensitivity to risk post Brexit referendum," says Krpata. (EUR/GBP at 0.92 gives a GBP/EUR rate of 1.0870).
While the spending measures announced by Johnson this week have underwhelmed markets, most economists agree on one thing: the Government is clearly signalling a return to austerity is not likely, which would have arguably slowed down any economic recovery.
"The prime minister’s recent comments signal that his government is unlikely to return to austerity, and we, therefore, suspect the borrowing requirements for the next fiscal year (2021) will still be fairly sizeable - and probably much more than the Office for Budget Responsibility initially estimated back in April," says Smith.
"At least the announcement signals that the government’s intention is to sustain the fiscal stimulus further ahead, rather than lurch towards fiscal austerity as it did after the Global Financial Crisis," says Gregory.