Budget 2020: Is the policy announced enough to avoid a recession?

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12/03/2020
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We can’t remember a precedent for the Bank of England (BoE) cutting interest rates on Budget day. Having checked through the data, there has been no such coincidence back to at least 1950, way before the BoE could set interest rates independently.

The fact that policy makers have chosen to deliver coordinated fiscal and monetary stimulus to the economy in concert is both unusual and noteworthy. Noteworthy because the BoE is fiercely protective of its independence and has avoided rate changes around budget announcements. The coordinated action probably speaks mainly to the need for non-monetary solutions to both the growth challenges ahead and the severity of the current situation. GDP numbers released on 11 March show that the economy has stopped growing. As the correction in equity markets has already signalled, stimulus is now required in order to reignite that growth. Is the policy loosening announced likely to be enough to avoid a recession? We suspect not, and markets will undoubtedly remain volatile as they process the likely extent of the growth challenges ahead.

Some of the budget announcements were commitments to current spending. In very basic terms, current spending is expenditure on wages and raw materials, it is short-term and has to be renewed each year. Of the announcements today, the open-ended commitment to NHS funding in order to get through the current COVID-19 threat would be one example. Similar examples would be the hardship fund announced today, along with the tax cuts. These totalled roughly £30bn but were dwarfed by the much larger capital spending commitments over the next five years which totalled a whopping £600bn. Capital spending usually involves building things such as roads, or hospitals, but it can also involve intangible investment spending too. These capital spending plans, by their very nature, tend to be longer-term. It would be difficult, no matter how desirable, to front load that £600bn into this year, let alone the next few months.

Nonetheless, the government, with this budget, has officially said goodbye to austerity. In tilting the spending heavily into the capital arena, this spending creates a physical asset, which sits on the opposite side of the balance sheet to the incurred cost (or government debt). Indeed, some infrastructure assets can be argued to produce a return on investment that can be measured. For example, HS2, the governments high speed rail project is expected to create an extra £15 billion a year in economic output once completed (KPMG Report, 2015). This type of infrastructure spending is multi-generational with the benefits of spending today not being felt until far into the future (the project is expected to be completed between 2035 and 2040). Therefore, it could be argued that capital spending now is for future generations as they will get the benefits.

Not only could these capital spending projects be viewed as socially responsible, but a strong argument could be made that this is also perhaps the perfect time to be borrowing the money to pay for them. Government borrowing costs are now at record lows so there has never been a cheaper time for the government to borrow money. Not only this, but with the recent market shock, and the economic impact of the COVID-19 on global growth still unknown, fiscal spending could be one of the only tools government has left to reignite growth. Unfortunately, from the measures announced by the government are unlikely to have inoculated the economy from COVID-19, a recession now seems likely. While we may have said goodbye to Prudence, we suspect that it may be a while before we see her smile again, as the growth risks remain. It may take significantly more current spending than announced to get the economy growing again. That said, thankfully the economic impact of past epidemics such as this one has been short lived. We remain vigilant.

Rowan Dartington is part of the St. James’s Place Wealth Management Group. Rowan Dartington & Co Ltd is a member firm of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales No. 2752304 at St. James’s Place House, 1 Tetbury Road, Cirencester, Gloucestershire GL7 1FP, United Kingdom.