Boris Johnson poses a new challenge to the BoE

By MARCUS ASHWORTH / BLOOMBERG

WITH two weeks to go until the UK election, plenty can change — especially when Brexit allegiances are testing old party loyalties like never before. But with the ruling Conservatives leading consistently in the opinion polls, it’s worth at least pondering the prospect of a Boris Johnson (picture) majority government.

The Bank of England (BoE), especially, will be running the numbers on that outcome as it will change its view on interest rates. Government spending is coming back with a vengeance regardless of which party wins.

While the Tory fiscal plans are dwarfed by the Opposition Labour Party’s by a factor of about six to one, they’re still a departure from the old austerity politics. Johnson’s proposals would take total government spending to about 41% of GDP, similar to Spain. The Tory election manifesto was surprisingly light on concrete spending plans, but projects would doubtless be found to reach the ceiling of a new higher fiscal cap.

The BoE’s economic outlook estimates have been dominated by Brexit; it will soon have to adjust too for the return of fiscal activism by the British state. The weakness of the European and global economy — and the loosening of monetary policy from the US Federal Reserve to the European Central Bank — will probably force the UK’s central bank to look at cutting rates in the short term.

Over the medium term, however, government spending rises will encourage tightening.

Of course, Brexit is still critical. Even if Johnson wins and gets his Brexit deal through Parliament, we’ll then move into the thorny stuff: The trade talks with the European Union that Johnson promises to complete at breakneck pace in 2020.

Until that trade deal’s delivered, the BoE will be in the dark about Brexit’s final shape. It’s possible that Britain could leave the bloc without a trade agreement at the end of its Brexit transition period.

The bank can be certain, though, about that increase in state spending.

Bloomberg Economics’ Dan Hanson has run a scenario analysis of Chancellor Sajid Javid’s plans that estimates he can borrow another £20 billion (RM108 billion) a year, as he relaxes the old fiscal rules. The Tory plans could boost yearly GDP by about 0.5% in 2021, rising to a 1% annual increase over time, Hanson reckons. That’s the fiscal equivalent of about a one percentage point cut to interest rates. Should Johnson prevail, the BoE’s growth and inflation forecasts would have to be revised upward.

At the central bank’s last policy- setting meeting on Nov 7 there was a split 7-2 vote with external members Michael Saunders and Jonathan Haskel voting for a rate cut. The Monetary Policy Committee signalled that a further softening of the global and domestic economy could swing other members toward easing. The choreography of all of this is a dilemma for the BoE. Fiscal spending takes time to feed through to growth and wage inflation.

So, if the economy does keep struggling in the next few quarters, or there are any nasty Brexit surprises, the bank might well need to add monetary stimulus. But if stronger growth then follows because of any spending splurge, it will have to be ready to hike again.

Whatever happens, the balancing of Brexit and Britain’s new fiscal regime will demand far more active management from the BoE than we’ve seen in recent years. — Bloomberg


This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.