Is the UK really a financial safe-haven?

27th March 2012

There also remain some doubts as to whether the UK's fiscal credibility will endure.

Tyler Durden on Zerohedge is unequivocal in his view that the UK is no safe haven: "Britain's ‘safe-haven status' is a fallacy. It is no more safe than many of the other major economies who are choking on debts that cannot be paid off. The only reason it HAS that status currently is because of the very Achilles Heel that will ultimately prove to be its demise – the ability to print its own currency. By NOT being a part of the euro experiment, Britain has kept control of its fate and has been able to print its way out of trouble – so far – while its neighbours to the east have all been lashed to the deck of the same sinking boat, but the day is coming when Britain's profligacy will become important again. As I keep saying; none of this matters to anyone until it matters to everyone."

Certainly, there are a number of independent think-tanks that believe Chancellor Osborne needs to accelerate his deficit reduction programme before he loses his reputation for prudence. Reform, which describes itself as an independent, charitable, non-party think tank, says in its recent report:

"The chancellor should tighten policy, because his reputation for fiscal credibility is already at stake. Confronted by poor economic growth last year, he did not toughen his spending plans. Instead, he moved the goalposts and postponed his target to eliminate the deficit by another two years. This is a vital budget for the chancellor to demonstrate that he will deliver on his original promise."

The Social Market foundation also argues for an acceleration in the speed of fiscal consolidation, bringing forward around £15bn in budget cuts or tax rises by 2016. 

As it turned out, the Chancellor stuck to his fiscally neutral position in last week's budget – there was no tightening of policy. Reform believes that the Government needs to ‘look again at the protected budgets of healthcare and schools'. It points out that: "Of the necessary spending cuts, only one pound in twenty has been achieved so far. Sir Nicholas Macpherson, the permanent secretary to the Treasury, recently emphasised that the Treasury forecasts public spending to be even tighter in the first two years of the next parliament than in this one." 

Much of the mainstream economic media still believes that the UK's fiscal policy is sound, even if they also argue for tweaks. Jonathan Portes of the National Institute of Economic and Social Research and previously chief Economist at the UK Cabinet Office writes on his ‘Not the Treasury view' blog that Chancellor Osborne's hard-won fiscal credibility is in tact. In fact, when David Smith of the Times, accused him of suggesting that the UK wasn't fiscally credible, he replied: "If I thought that the UK lacked fiscal credibility, I would not be arguing for a temporary, short-term fiscal stimulus to boost output and employment.  It is precisely because we have fiscal credibility, and are in no danger of losing it, that such a policy could yield significant benefits with little or no downside. David is quite correct that "the verdict of the markets is more important than that of the rating agencies".  And what are the markets actually telling us?  As Martin Wolf puts it "They are saying: borrow and spend, please."

This FT editorial (paywall) suggests that the Chancellor in fact, need to continue on his current fiscal path – exactly as he did in the budget: "He should refrain from making any more immediate cuts. His concern should be to stick to the spending path he has staked out. Since the global outlook is so uncertain, there is a strong economic case for staying put."

The position of the ratings agencies has been clear. The UK needs to stick to its austerity plans and hope for the best: "By historic standards, the scale of the fiscal challenge facing the UK is amongst the most demanding. The autumn statement in November 2011 extended real cuts in public spending to financial years 2015-16 and 2016-17, beyond the term of the current government. With a weak economic recovery that is vulnerable to adverse shocks such as higher oil prices and the Eurozone crisis, the risks to UK fiscal consolidation are material.". In the meantime, the AAA rating is on watch.

Staying put is certainly the path of least resistance for the Chancellor. If things go wrong from here, he can always blame the Eurozone situation, rather than whether he cut too much or too little. However, Britain's fiscal credibility remains in the balance and this is likely to make any plans for long-term gilt issuance difficult to put into practice. 

 

More from Mindful Money:

100 year bonds: Method behind the madness

The impact of ratings downgrades

The 'Safe Haven' Illusion

To receive our free email newsletter sign up here.  

Leave a Reply

Your email address will not be published. Required fields are marked *