Autumn statement boosts BoE doves

The 2014 autumn statement from the Chancellor of the Exchequer could be dubbed as the statement of downward revisions, as forecasts for growth, borrowing, unemployment and inflation were all revised down for 2015 and beyond. The unavoidable implication for currency traders is that the Bank of England will find it nearly impossible to raise rates in 2015. The fiscal-monetary policy mix will not help, and falling government revenues from North Sea oil will outweigh any windfalls for consumers.

The most headline-grabbing component of the autumn statement was the reform in stamp duty on residential property, in a way that rates only apply to that price component falling within each band, instead of on the entire property price.

Lower growth, borrowing, unemployment and inflation

There was no surprise in the upward revision of 2014 GDP growth to 3% from 2.7%; but 2015 growth was revised to 2.4%, followed by 2.2%, 2.4% and 2.3% in 2016, 2017 and 2018 respectively. Government borrowing is seen falling from £97.5 bn in 2013-14, to £91.3 bn in 2014-15. The deficit is expected to fall to £75.9 bn in 2015, £40.9 bn in 2016 and £14.5 bn in 2017, until reaching a surplus of £ 4bn in 2018 and £23 bn in 2019-20. Unemployment is seen falling to 5.4% in 2015 from the current 6.0% and inflation is predicted at 1.5% in 2014 before slipping to 1.2% in the following year.

And falling tax receipts

Government tax receipts are also expected to fall, coming in £23 bn lower in 2014-15 than expected in March. Growth of income tax and national insurance has slowed to 1-2% from pre-crisis levels of 6-7%. Falling oil revenues have also weighed on receipts, in terms of both volume and price. And despite falling unemployment, low wage growth was another major element of lower income tax receipts, especially highlighted by the increase in personal allowance s i.e. the tax-free portion of income that’s exempt from tax. But the January figure of income tax receipts will likely get a boost as people delayed their tax payment to take advantage of the decrease in the tax rate from 50% to 45%.

Wrong policy mix for sterling bulls

Unlike in 2010-2012, when tight fiscal policy operated alongside ultra-easy monetary policy from the Bank of England’s quantitative easing and the pound’s stimulative depreciation, the upcoming round of fiscal consolidation emerges alongside more hawkish expectations for interest rates and a higher pound. If you thought the BoE was hesitant to tighten rates in 2015, then further fiscal consolidation and lower tax receipts will make any rate hike less likely.

Lasts month’s release of the BoE’s quarterly inflation report pushed market expectations for the BoE’s first rate hike to Q4 2015, compared to the Q1 2015 earlier this summer. We would not rule this out if these expectations are further pushed out to Q1 2016. The charts below highlight the increasingly positive correlation between the GBP/USD rate and UK and US ten and two-year yield spreads. The UK/US ten-year yield spread has plunged to its lowest level in eight years. And even if the Fed refrains from tightening next year, the relative interest rate expectations remain slanted against the Bank of England. GBP/USD could post its first monthly gain after five straight declines. A bounce towards 1.5790s is as viable as a subsequent pullback to 1.5400s.