FTSE at record high as pound falls
06 Oct 2016
Brexit plan fuels currency drop, says LBS economist
As the FTSE 250 share index hit an all-time record at 18,407 and sterling fell to a 31-year low, a London Business School economist says we should expect years of economic uncertainty.
Linda Yueh, Adjunct Professor of Economics, London Business School made the remarks writing in Forbes, having spoken at the Conservative Party Conference fringe event.
The Chancellor and Prime Minister used the conference to set out a timetable and seemed to suggest that Britain will not remain within the Single Market after Brexit. The two announcements led to the currency drop as well as the rise of the FTSE 100 index.
Commenting on the inverse correlation between the pound and stocks, Linda Yueh says: “A large part of the rise is due to the preponderance of export-oriented listed companies that sell to the global market. And their expected earnings are marked higher by a weaker currency.”
The big surprise, according to Yueh was that the bond market didn't react following the Chancellor’s speech. “The Chancellor outlined a plan to ditch the 2020 budget surplus target and indicated that the UK government may compensate firms negatively affected by leaving the Single Market.
“Philip Hammond had, of course, previously suggested that Brexit means fiscal policy will be re-considered. In a sense, Brexit has provided a reason for the new government to change course,” says Yueh. “But, actually, the global context has also shifted.”
Globally, bond yields are at historic lows, fueled by central banks' negative interest rates and expectations of slow growth in major economies. “That is indeed what investors are now looking for; economies that are growing rather than those in a post-2008 financial and euro crisis environment,” Yueh explains.
“That's why the consensus is shifting around public investment, notably on infrastructure,” says Yueh.
“Governments can borrow at negligible rates so it is an opportunity to take advantage to rebuild investment slashed during the recession. Indeed, the Chancellor suggested that he was open to considering investment as separate from day-to-day government spending. The question is will he borrow to invest? Other governments are contemplating the same question,” says Yueh.
Borrowing to build digital infrastructure or better transport systems is different from current public spending. “Markets would be able to discern the difference and not judge all increases in the budget deficit the same,” Yueh believes. “The muted response of the bond market suggests that is the case and greater fiscal flexibility doesn't trigger ‘punishment’ from the markets with rising borrowing cuts.”
During his speech the Chancellor also hinted that the Government would compensate firms hit with higher tariffs in post-Brexit Britain.
“How he will pay for that, as well as any investment, will matter,” says Yueh. “We likely won't find out until the Autumn Statement on 23 November. And let's see how the bond markets react then.”