The U.K.’s Date with Destiny

October 19, 2010 by SIMON NIXON

The U.K. government’s spending review will be one of the defining political events of the year—if not the decade. Chancellor George Osborne will set out Wednesday how he plans to cut the budget deficit by eight percentage points in five years, the fastest and deepest fiscal consolidation in the country’s post-war history. But from the City’s perspective, this may not even be the most important economic event that day.

No one doubts the cuts will be tough. But the scale of what is planned has been known since June’s post-election budget. All that is being revealed on Wednesday is where the ax will fall—which has less macroeconomic significance. Of course, the City will react badly if the government backslides on its spending plans. But the Treasury has dismissed reports it is seeking to “reprofile”—or reschedule—cuts, except where it is unavoidable.

In the City, the debate over how far or how fast the deficit needs to be cut was settled long ago. Gilt yields have fallen sharply since June, outperforming Bunds. Indeed, for all the political noise surrounding the cuts, 85% of the tightening in government borrowing was planned by the previous Labour government; the coalition is only tightening fiscal policy by an extra 0.2 percentage point of gross domestic product this year, notes Bank of America Merrill Lynch.

The major uncertainty is whether the cuts are implemented in a way that threatens future growth either by cutting investment in crucial areas such as education and infrastructure or by undermining confidence. But the evidence from previous fiscal consolidations suggests these risks are exaggerated; the U.K. economy grew by an average 3% in the mid-1990s despite almost as sharp a reduction in the budget deficit.

More importantly, the private sector is already demonstrating it can generate sufficient jobs to offset public-sector cuts. The public sector is already on course to eliminate 100,000 jobs this calendar year, the same pace at which it is expected to cut jobs in coming years, yet the private sector has created 340,000 jobs this year.

Sure, this pace of job creation will be hard to sustain. But the key to doing so is the future direction of monetary policy rather than the details of the comprehensive spending review. That’s why it is the publication of the Bank of England Monetary Policy Committee’s latest minutes, expected to show a rare three-way split that is likely to be the main focus of U.K. investor attention on Wednesday.


Write to Simon Nixon at


Source: Proshare


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