The U.K. May Really Embrace Fiscal Stimulus This Time

Small instances of politicking aren't usually of concern to global investors. But they may want to make an exception for the ousting of the U.K.'s Treasury chief.

On Thursday, Sajid Javid announced his resignation as chancellor of the exchequer (https://www.wsj.com/articles/u-k- treasury-chief-resigns-amid-government-reshuffle-11581597849), as part of a larger cabinet shuffle by British Prime Minister Boris Johnson. It may herald a Trump-style fiscal boost to the U.K. economy, which would support both sterling and the shares of companies exposed to the domestic economy.

Mr. Johnson's landslide victory in December's election was predicated on moving away from the austerity recipes of earlier Conservative Party governments--a shift promoted by his chief strategist, Dominic Cummings. This, combined with the pledge to follow through on the result of the 2016 Brexit referendum by finally leaving the European Union (https:// www.wsj.com/articles/after-a-turbulent-marriage-britain-says-goodbye-to-the-eu-11580477936), managed to sway traditional left-voting constituencies in the north of England.

But the purported fiscal push lacked credibility. Mr. Johnson's predecessor, Theresa May, had already promised a reversal of austerity policies, but met staunch resistance from then-Treasury chief Philip Hammond. Mr. Javid, a former investment banker who idolized Margaret Thatcher's governments in the 1980s, also seems to have pushed back against Mr. Cummings's plans, including wildly expensive infrastructure projects supported by the prime minister like the problem- ridden "HS2" high-speed rail line.

Small rollbacks in austerity have proven insufficient to boost the country's growth, especially given the recent China-led manufacturing slowdown. This week, official data showed that British national output was flat in the final quarter of 2019.

Mr. Johnson's election pledges would require around GBP40 billion ($52 billion) of borrowing over the next fiscal year, analysts say. But Mr. Javid had simultaneously promised to enforce strict rules. December forecasts by the U.K.'s independent fiscal watchdog, the Office for Budget Responsibility, suggested that a weaker economy gives him no room to follow both paths.

Now, there is a chance that his successor--former Treasury No. 2 Rishi Sunak--will ease those self-imposed constraints in next month's budget. Mr. Javid said that his resignation came after the prime minister asked him to replace all his senior advisers. This seems to be a signal that Mr. Johnson's ideological shift is real, and that supporters of fiscal stimulus are taking over.

The pound gained 1% on Thursday against the euro, closing at its highest level since 2016. Despite the headwind of a stronger currency, the more domestically focused FTSE 250 midcap stock index has gained 1.1% this past week, almost as much as eurozone equities. They may have further upside if government spending truly ramps up, especially because government-debt returns remain too low to offer an attractive alternative--the 10-year gilt yield is at 0.64%.

While fiscal spending will lift bond yields a bit if the economy heats up, they should remain contained. Central bankers are now realizing that inflation doesn't mechanically follow faster economic growth, and the Bank of England is likely to ape its peers in keeping interest rates low.

Opening the fiscal taps was a key fuel for U.S. markets in 2017. The strategy is unlikely to be carried out on the same scale in the U.K., but investors shouldn't underestimate its potential impact on the country's assets.

Write to Jon Sindreu at jon.sindreu@wsj.com (mailto:jon.sindreu@wsj.com)

-Jon Sindreu; 415-439-6400; AskNewswires@dowjones.com


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  02-14-20 1013ET
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