This week, the UK Spending Review and the accompanying updated macroeconomic forecasts from the Office for Budget Responsibility (OBR), gave a sobering view of the enormous economic impact of the Covid crisis – or as the Chancellor phrased it, “our economic emergency” that has “only just begun” – but also a glimpse of investment commitments and priorities that will emerge as the UK exits the health emergency and indeed, the confines of the European Union. Sunak made some tough decisions (a controversial cut to the international aid budget and a public sector pay freeze – albeit with an exemption for front line NHS workers), but essentially based the Review’s targets around 3 key areas:

(i) Protecting lives and livelihoods in the face of the ongoing Covid crisis;

(ii) Stronger public services – building on government commitments on schools, hospitals and policing;

(iii) a “once-in-a-generation investment in infrastructure”. The Comprehensive Infrastructure Plan includes road, rail, hospitals, schools, as well as broadband and mobile connectivity, and zero emission buses and other vehicles, not to mention commitments to R&D and the goal of a post-Brexit UK becoming a Scientific Superpower, all facilitated by the creation of a new Infrastructure Bank.

The OBR growth forecast updates showed an expected fall in GDP for the current financial year of 11.3%, the biggest annual decline in UK GDP since the Great Frost of 1709 (though even the most maverick history buffs are unlikely to be expecting to see an elephant walking across a frozen River Thames in a repeat of the Frost Fairs of the early 18th Century – even if 2020 has taught us to be cautious not to rule anything out!), with rebounds of 5.5% and 6.6% subsequently taking the UK economy back to pre-Covid levels in Q4 2022 - a pace that leaves a growth deficit of 3% GDP by 2025 relative to March forecasts. Of course, all of the aspirations of the UK, on top of a growing debt pile, will require higher taxation (likely across the board), and that will itself alter the OBR forecasts – but for now, at least, that is an issue for another (warmer) day.

In this context, it is also interesting to note the OBR’s assessment of the further impact on UK growth if the UK/EU fail to reach an, albeit skinny, FTA in the narrow window remaining (our ‘week’ in politics was not long enough after all). While our view remains that there will be a deal, and that both sides very much want a deal, it is also clear that the additional 2% loss of GDP for not securing a deal is likely small enough to prevent concessions at this late stage that would unduly restrict the longer term growth opportunities that constitute the ‘case for Brexit’ in the first place. Indeed, it is not clear when the ‘last moment’ to reach a deal is, given that so many deadlines have come and gone, and the fact that the UK Parliament is likely less ‘time constrained’ than the EU. My guess is that the middle of next week is the last minute – and that a deal will be ‘triumphantly’ reached at some point, probably marginally after – and possibly followed by a (likely caveated) EU granting of UK financial services equivalence.

The other core factor that the OBR drew attention to with its forecasts is the extraordinary level of debt that national governments have required to fund the health (now evolving into economic) emergency. Government spending in the UK rose to 56% GDP this year and borrowing will rise a further GBP 394B next year or 19% GDP. Greater fiscal dependence has also blurred the lines between central banks and government – between monetary and fiscal accommodation. In the UK, the lower flatter yield curve has effectively reduced the cost of borrowing (by GBP 20B next FY alone) and in the UK, Europe and the US (not exclusively), asset purchases under QE extensions are increasingly a means of providing liquidity for government borrowing – monetary financing in all but name!

Against this backdrop, the Federal Reserve (the Fed) also released the minutes from the November 5th FOMC meeting this week through which it gave a relatively balanced or symmetric policy outlook – maintaining the ability to boost the pace, extend the maturity of asset purchases if needed, while also discussing the necessity for an enhanced guidance (path to normalisation) on the evolution of its bond buying and the criteria (likely economic as opposed to time-based) required to facilitate the move. In doing so, the Fed intimated that while it may not be ‘thinking about thinking about’ raising rates, they are ‘thinking about thinking about’ the process by which they may reach the position to ‘think about thinking about’ raising rates: tapering bond purchases. Ultimately, while we remain of the view that the Fed will lead the monetary normalisation process, they will likely remain accommodative for many quarters if not years to come.

In drawing all this together, we have a clear view that the single most important factor for national economies going forward is growth. Not just the pace of the re-opening rebound, but in the longer term sustainable or trend-potential growth rate. This will be key in overcoming the debt shock, fostering sustainable reflation (and thus debt deflation) and in our view there will be some clear winners. The US and China are our standout views, as their dynamic, tech-driven economies lead the new tech revolution and widen their positive growth differentials. In Europe, Germany is also in a relatively strong position, but will likely be weighed down by much of Southern Europe’s combination of low potential growth and high debt. For the UK, a lot will hang on the decisions of the next couple of months: on Brexit and the potential for structural reform, on levelling-up and tackling the regional productivity gap and on tech. The Chancellor stated this week that the economic emergency had only just begun; but from a long-term perspective, perhaps so too has the opportunity?