The gilt market is down. The pound is really down. The faces below the blue-rinse in Brighton are grim (despite the Spectator thinking the speech was just fine). All because of a YouGov poll in the Sunday Times (see LibCon premature celebration) – apparently.
The logic should be clear. In a crisis the Labour party is so 1976; determined to spend more than we can afford, print more money than we should, run risks with our national solvency to chase a level of economic growth we don’t deserve because of our past sins. The Conservatives have grimly set their faces to the task of cutting through this nonsense, just as they did in 1979. Back then, Maggie was Not for Turning. From there on, gilt yields fell steadily, Britain regained its solvency, all sorts of good things happened.
Now the stinky polls are suggesting the opposite. Bad poll on Sunday – sterling carnage on Monday. The pound down 1.7%, gilts down too. Apparently a significant portion of the internet just crashed, as various right wing bloggers all attempted simultaneously to write some stirring nonsense about the return of the IMF ….
So is Labour bad for the Pound and the Gilt in your pocket? I’m not sure one can prove it so easily. Here is the evidence so far (since October):
Again, you can see the drift. But, critically, you also get long periods where the movements are utterly apart. From 1st Oct to 17th Feb, the poll lead stays roughly at 12, and the gilt yield rises by 60 basis points. Then, since 17 Feb, the poll lead shrinks, and the gilt yield is roughly where it was.
What about the pound itself? Here is a similar graph:
If I were to come out with a verdict, I would say there is some evidence that a Tory government is perceived to have different effects on markets than a Labour one. But I would question whether this can be broken into a ‘Labour Bad for Britain’ story. Gilt yields can be kept low in several ways. One neat trick is to impose spirit-crushing deflation on your economy in the mistaken belief that it’s 1976 outside and deflation is what we need. Then, suddenly, a gilt promising to repay 4% looks quite good (except the government may be insolvent).
The pound, too, reflects many concerns. Buttonwood reminds us that Prudential buying a bit of AIG has an effect; a massive transfer causes currency disruption.
For me, the major movement of the last 3 months – since the pound peaked, basically – has been a downgrading of our growth prospects. It is detectable explicitly in the Bank’s statements, but also in the market. Gilts fell as growth looked likely to return, till about Feb, since when they have flatlined. 3 months ago, a lot of people thought QE was done for good. Now they are not so sure: King thinks it may have to restart.
Poor growth may mea:
(a) confusion for the Tories, whose policies of hard retrenchment were perhaps excusable if the economy grew gangbusters, but very ropey if not. This may have been detected by the polled electorate who shift to Labour and
(b) weaker sterling.
What we might be observing is a single thing causing two separate outcomes, not the polls causing the sterling crisis. Why gilts have not been stronger is more of a mystery to me, but today, in fact, the Pound is down far more than the gilt. More QE to support a weak economy is being contemplated.
You are on a hiding to nothing if you try to map political events onto sterling movements. As Chris Giles observes, it is not even a cert that Hung Parliament means Slower Fiscal Work. The parties may perceive their political interests to be on the side of the Tough Cutters, in which case the market may be fearing a further slump, not a credit-default/inflationary default.
On the other hand, as Wadhwani observed in the FT a month or so ago:
I have lost count of the number of times someone has recently asserted that a fiscal tightening in the UK will lead to a lower exchange rate . . . A larger than expected degree of fiscal consolidation would reduce the risk of such a crisis and would probably cause sterling to go up, not down . . . s per conventional wisdom, a hung parliament would make fiscal tightening less likely. Using the textbook model, this should make interest rates and sterling rise. However, in my opinion, the higher probability of a crisis would almost certainly lead the pound to fall.
So which is it to be: textbook or commonsense or neither?
UPDATE: also bear in mind the problem policy makers have of treating sterling falling as a sign (bad) or as a tool (good, because it boosts exports.) Charles Dumas of Lombard, says:
The best, or rather least bad, course for the UK economy is probably the quite vigorous recovery leading to financing strains for the country and its government, followed by forced fiscal tightening. To “front-run” with tighter budgets, ahead of proven economic recovery runs too great a risk of supporting sterling and aborting recovery.
Like Wadwhani, he sees a risk that Tory policies BOOST sterling. Strong pound, tight fiscal? 1980. Oh, except without the boom from oil impending, the strong banks, and the debt at only 45%. Not good – not what they are aiming for surely.
To gain further insights into this subject, you know what to do. Read my report. Please.