November 21, 2017 / 2:11 PM / a year ago

Commentary: One more sterling risk that may be less than first thought

LONDON (Reuters) - Given the disarray the British government finds itself in right now, there’s not an insignificant chance of the country enduring another general election next year and left-wing Labour leader Jeremy Corbyn becoming an unlikely prime minister.

U.S. dollar and British pound notes are seen in this November 7, 2016 picture illustration. Picture taken November 7. REUTERS/Dado Ruvic/Illustration

It’s a prospect that would see more than a few investors and sterling traders in particular break into a cold sweat. Which is odd, because the gap between many of the government’s and opposition’s economic policies is smaller than you might think.

Finance minister Philip Hammond delivers his annual budget on Wednesday, and is under pressure to take steps to counter slowing growth, falling real incomes and weak productivity, all under the cloud of uncertainty that is Brexit.

It could be the last budget before the country goes to the polls again, with bookmaker Paddy Power putting the odds of an election next year at 9/4 - or a 30 percent probability on what would be the third election in three years.

One of the battle grounds would be the economy and public finances. Yet despite all the rhetoric from both sides, there’s less clear blue water between them than first meets the eye.

After the banking collapse and rescue of 10 years ago, then chancellor George Osborne committed the Conservative-led government to years of austerity which he claimed was necessary to get the public finances back to health - a policy only modestly loosened to date by his successor Hammond.

After losing the election in 2010, Labour largely accepted Osborne’s line on tighter public finances even if it differed on speed and scope. Only since Corbyn was elected leader and John McDonnell appointed shadow finance minister in 2015 has the party stepped up its opposition to spending cuts and adopted a more traditional Labour approach to taxation and spending.

And now it’s the Conservatives, chastened by its unexpectedly poor showing in this year’s election and wary that the country is suffering ‘austerity fatigue’ after seven years of a public sector squeeze, who are softening their position.

Conservative politicians who only recently derided Labour’s plans as fantasy and claimed there was no “magic money tree” are now talking of new spending.

Local government minister Sajid Javid last month called for a “giant leap” in housebuilding, which sources told British media would require public investment of up to 50 billion pounds ($66 billion).

That may be relatively small beer compared to McDonnell’s idea of a newly-created National Investment Bank making up to 250 billion pounds available for investment over 10 years.

But even though spending on even that scale would normally be anathema to ‘Tory’ supporters, conservative magazine The Spectator ran an article last month entitled: “If the Tories want to survive they must build more houses”.

While Hammond may stop short of throwing huge amounts of cash at housing, new building will be a feature of this week’s budget and he is also under pressure to be more flexible in reducing the so-called ‘structural deficit’ to 2 percent or less by 2020-21 as Brexit headwinds drag on the economy.

And the economy is slowing. Some economists are penciling in sub-1 percent growth next year as Brexit hits investment and falling real wages choke consumer spending, all against the backdrop of chronically weak productivity growth.

Loosening the government’s purse strings would help cushion these blows. And with interest rates and government bond yields close to their lowest levels in history, there’s rarely been a cheaper time to borrow.


More surprising, perhaps, is the government’s U-turn on intervention in the “broken” energy market. Bowing to pressure from a large swathe of her own MPs, May said last month the government will put price caps on “rip off” energy prices.

That’s a way short of renationalization of parts of the sector, which Labour proposes along with rail, water and postal services. Yet a Tory government imposing price caps on a ‘free market’ - exactly the Labour proposal it lampooned in the 2015 election - is another unexpected swing toward the policies of its rivals.

Public sector pay too is an area where the government once insisted it had no wiggle room. But May and Hammond have already set out plans to scrap the 1 percent freeze on pay rises that’s been in place since 2011.

The narrower gap between party positions that at first glance also speaks to another often overstated ‘truism’ of British politics and its interpretation by financial markets.

A widely-held view in British politics is that Labour governments hurtle the country toward fiscal ruin with reckless borrowing and spending, while Conservative governments run a tight ship and keep an iron grip over spending.

The reality is slightly different though. Since the Second World War, there have been only 12 years in which the government of the day has run a budget surplus - four of them Tory administrations and eight of them Labour.

Sterling is less vulnerable to the British government’s budget position than the country’s overall balance of payments. In the words of Bank of England governor Mark Carney, Britain relies on the “kindness of strangers” to balance its books.

The current account deficit has narrowed from a record 7.1 percent of GDP in late 2015 to 4.6 percent at the end of June this year. Britain has run a deficit with the rest of the world for almost all of the last 30 years, a shortfall that must be met with capital from abroad.

Governments of both stripes have presided over that 30-year deterioration and accompanying slide in sterling. With the BoE tentatively raising interest rates and Brexit casting a huge cloud of uncertainty over the economy, the pound’s near-term fate won’t be decided by a surge in public spending.

The opinions expressed here are those of the author, a columnist for Reuters

Reporting by Jamie McGeever, Editing by William Maclean

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