So far the UK economy is performing well, according to the OECD Weekly Monitor (until 09/17). But (understatement of the year), challenges arose.
Figure 1: Weekly tracking (blue), in %. Source: OECDECRI and author’s calculations.
The OECD Weekly Tracker reading of 1.4 is interpretable as an annual growth rate of 1.4% for the year ending 9/17. How effective is the OECD Weekly Observer for the UK? Here are two images, for quarterly GDP and for monthly GDP (the monthly is the official ONS series, unlike the US monthly GDP I reported, which is from IHS Markit).
Figure 2: UK real GDP year on year at quarterly frequency (teal), inferred from Weekly Tracker (black), in %. The Q3 observation is for data up to 9/17. ECRI has marked peak-to-trough recession dates in light green. Source: OECD via FRED, OECDECRI and author’s calculations.
Figure 3: UK real GDP year on year at monthly frequency (teal), inferred from Weekly Tracker (black), in %. The Q3 observation is for data up to 9/17. ECRI has marked peak-to-trough recession dates in light green. Source: UK NSO, OECDECRI and author’s calculations.
Based on the negative GDP read in Q2 and its own GDP forecasts, The NIESR has already declared the UK in recession (Again).
Now, what about the tax plan (in the opinion of almost everyone, ill-conceived) presented by the new government? Well, to me, the reaction of the financial markets indicates a lack of credibility, insofar as the promised results will actually occur.
Interest rates on 10-year government bonds have soared, which makes sense as an increase in borrowing colliding with the expected tightening of monetary policy should boost yields. It is not clear to me that the increase in yields is purely driven by the forward structure expectation hypothesis; i.e. some of the increase may be due to the increased association of inflation risk with nominal bonds (not sure where one could get estimates inflation risk premia for UK gilts).
The decline in the value of the pound against the US dollar is counter-intuitive (at least to me) for a country whose government bonds would be perfectly substitutable for, say, US government bonds – that is- i.e. a situation where uncovered interest parity would hold. However, if the bonds are not perfectly substitutable, then one could resort to a portfolio balance model. The simplest version would indicate that an expected large increase in the supply of bonds would then lead to a depreciation of the currency. And that’s exactly what we saw. While the parameters of the so-called mini-budget are not too different from what was expected, it seems that the announcement of two – rather than one – tax cuts in the context of already large budget and trade deficits erodes credibility.
All I can say: I’m glad I don’t have to sell this tax package to anyone…
Oh, while the first self-inflicted injury is obvious, the second can be seen in the decline in the value of the pound in 2016 (which occurred in June of that year). This fall in the real value of the pound means a deterioration in the UK’s terms of trade…