‘Borisnomics’ could mitigate a Brexit bust
Since entering No. 10, Boris Johnson’s political strategy on Brexit has been to take a hard line stance with the EU. At the very least, the Prime Minister (PM) appears to be hoping that by threatening ‘no deal’ — and circumventing parliament — the EU will renegotiate the backstop on the Irish border.
Regardless of how the politics shapes up in the autumn, we expect the new government to crack on with policies to mitigate the economic risk of a no deal Brexit. We see four key areas where this so called ‘Borisnomics’ could ease investors’ fears from leaving the EU without a withdrawal agreement.
At the heart of the Johnson administration’s Brexit toolkit will be a rolling back of austerity to lift economic growth over the medium term. Based on data from the Institute of Fiscal Studies and the PM’s announcements, we find that the government’s fiscal stimulus plans - income tax and national insurance contributions cuts, plus more expenditure on education, NHS and the police — could increase by over GBP30bn (1.4% of GDP) cumulatively by 2023/24.
Taking into account this fiscal stimulus, the government is at risk of breaking the 2% structural (i.e. non-cyclical) budget deficit target rule established under the Charter for Budget Responsibility in 2010. However, the new Chancellor, Sajid Javid, could modify current fiscal rules to give the government more spending and tax cutting headroom.
For example, were the government to scrap its structural budget deficit target and change the fiscal charter simultaneously to keep public debt to GDP constant, we estimate it could free up around £233bn GBP (9% of GDP) in cash over the next four years. While such a large increase in state spending is probably unlikely under the Tories, there is the potential for the government to widen the deficit over the fiscal horizon should the impact of a no deal Brexit weigh on the economy.
Expect a loosening in monetary policy. While the Bank of England (BOE) sets UK policy interest rates independently, the Johnson administration will have a say on who will replace BOE governor Mark Carney when his term ends in January 2020. It is possible that a more dovish BOE governor is selected to fit in with ‘Borisnomics’ and that this appointment could steer: i) the Monetary Policy Committee to lower interest rates; ii) a new Quantitative Easing program by expanding the BOE’s balance sheet; iii) the BOE’s mandate to revise up the current 2% inflation goal. Such measures would allow for a more flexible approach in using monetary policy to navigate the business cycle in a post-Brexit world.
The government could adopt deregulation as part of its economic policy. In the past, Boris Johnson has talked about a divergence in UK rules from the EU in particular sectors to raise productivity and exploit new technologies. As a template, President Trump’s supply-side reforms of US deregulation to cut bureaucratic red tape, as well as tax cuts, led to a surge in small business confidence and accelerating productivity growth.
The housing market
Simplifying or reducing stamp duty could boost the housing market, an issue that has been favoured by Mr Johnson during his Tory leadership campaign. Considering the fairly strong relationship between house prices and private consumption growth, reducing property transaction costs could lead to a pick-up in housing market activity and provide significant lift to overall economic growth.
We believe that ‘Borisnomics’ could mitigate some of the apparent risks surrounding a no deal Brexit. Given undemanding valuations and the rise of the Tories in opinion polls that reduces the risk of a left-wing Jeremy Corbyn Labour government, UK equities are starting to look more attractive.
Incorporating trade sentiment in markets
The backdrop for world trade worsened in August. Although President Trump has pushed back part of the additional 10% tariff on $300bn of Chinese exports, Japan and South Korea have engaged in their own trade feud. The two countries removed each other from the list of trusted trading partners.
Motivated by the work of the Bank of England, we constructed a world trade sentiment index to help gauge how much of worsening trade sentiment is priced in by the market. When we take into account improving fundamentals (proxied by earnings revisions) and the support from central bank (proxied by lower global bond yields), we find that the market has fully priced in the sentiment around trade (see chart on equities section).
We believe this is a good investment framework to analyse what can be predicted (e.g. interest rates and company earnings) and what can’t (President Trump’s Twitter comments on trade).
In short, we find that the earnings improvement and easy monetary policy from central banks have offset worsening trade sentiment.