Knock-on consequences of the autumn budget

The UK’s fragile recovery is well placed and looks set to beat previous timeline expectations.

Headlines from George Osborne’s comments are that the UK’s recovery is underway, and that the economy is growing at a better pace than anticipated. The growth forecast for 2013 has been increased from the original assessment of 0.6% up to 1.4%, and the target for 2014 has been upped to 2.4%. This will eventually rise to 2.7% over the following four years.

The other side of the coin is the government’s borrowing, where we look set to continue to run an underlying deficit for the next five years. In 2013 borrowing is expected to come in at £111 billion, working its way down to an anticipated surplus in 2018/19.

The chancellor made clear before this statement that any extra benefits we received would have to be covered by taxes or savings from somewhere else. This neutral spending should be what the heads of the International Monetary Fund were hoping to hear; a control on the spending and a continuation of the country’s austerity.

One particular area where it appears that the UK has managed more successfully than its counterparts in mainland Europe is unemployment levels; UK’s unemployment looks set to fall to 7% by 2015. Part of the reason for this has been the wide-scale shift of corporate jobs away from longer-term and permanent employment to a greater volume of contract work. One of the most worrying trends that have emerged around Europe has been the massive unemployment levels of youth; in an effort to tackle this, the chancellor will be looking to remove the National Insurance tax that companies have to pay when employing under-25s.

A consequence of the improving picture for the UK economy has been the increasing strength in sterling. Since the beginning of July, just after Mark Carney took over as governor of the Bank of England, GBP/USD has risen by just over 10%, from 1.4813 to its current levels hovering around the 1.6325 area. In the short term the BoE will no doubt be monitoring this movement, but with the US debt-purchasing scheme likely to start being reduced sometime in the foreseeable future this could naturally rebalance to the current exchange rate.

Before that can happen, though, we envisage that, given the Monetary Policy Committee are no longer buying assets in an effort to spur economic growth, the next viable step for the UK central bank is to be the first to tighten monetary policy. As the UK is the fastest growing economy in the developed world, one could see the pound gain against the dollar over the medium term. Look for moves through 1.64 on a weekly closing basis to cement this sterling strength.

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