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“No alarms and no surprises"

- Radiohead, No surprises

This week, the UK government announced - and subsequently voted into policy - an increase to National Insurance (NI) (although ultimately it will become a standalone line in the country’s payslips as the ‘Health and Social Care Levy’) contributions in a bid to overhaul the Social Care policy of the UK (something that has been left in the ‘too difficult’ tray of successive UK governments for decades) and, at the same time, fund the catch-up of the NHS in terms of the exponential rise in its waiting lists. While the proposal passed the House of Commons, it has been widely condemned across the political spectrum of the UK’s press - for different reasons depending on the political persuasion of the publication.

While I have no intention of commenting on the political aspects of the proposal, I do have a couple of comments. Firstly, the UK is the first major economy to actively tighten fiscal policy in order to address the Covid related deterioration in public finances (in theory, the measures are fiscally neutral, as the money being raised in taxes is being spent on health and social care, but the money to reduce hospital waiting lists had to come from somewhere). It will therefore be an important test case to gauge the global capacity for fiscal tightening when the aftershocks of Covid have far from passed - particularly in terms of employment and consumption.

Secondly, it is perhaps interesting that in the same week that opposition parties in the House of Commons referred to the NI rise as Johnson’s ‘Poll Tax’ (the unpopular flat tax that ultimately brought an end to the 11 year premiership of Margaret Thatcher), that the European Central Bank (ECB) President answered a question at this week’s press conference with a clear and obvious nod to the infamous Margaret Thatcher quote from the 1980 Conservative Party Conference speech (ironically in refusal to U-turn on her liberalisation of the economy) - “The Lady’s not for turning”.

Over recent weeks, we have referred to the concept of an ECB ‘Taper’ as both disingenuous and misleading. The ECB pre-announced (and subsequently increased, twice) a total stock or envelope for asset purchases under the PEPP programme. We have been very clear that unless the ECB were to adjust (in this case truncate) the envelope, then the expected total stock of assets ultimately held by the ECB would be unchanged at a lower pace of purchases, thus the level of stimulus would also remain unchanged. This week, when the President was asked to comment on the ‘Tapering’ of ECB purchases, she responded “The Lady isn’t tapering”, instead describing the ‘moderately’ lower pace of purchases as a recalibration for the next three months. No alarms and no surprises.

Going into the ECB meeting, the commentariat debate was centred around an upgrade to the growth forecasts and upgrades to the inflation projections throughout the forecast horizon and thus, in conjunction with easier financial conditions (lower core yields, higher equities and a lower EUR). Ultimately, the latest staff projections upgraded growth for 2021 (to 5.0%) but left 2022 and 2023 largely unchanged (at 4.6% and 2.1% respectively). Inflation projections were raised across the forecast horizon, but only barely at the policy relevant 2023 (to 1.5%) - which still leaves a significant shortfall and thus the need for maintained accommodation.

Furthermore, there was a clear reference in the press conference transcript that “the ECB’s job is not done when the Pandemic is over”. From our perspective, this is important. While we have pushed back against the notion that the ECB ‘taper’ was the correct terminology, let alone comparable to a Fed taper (of its open-ended QE programme). The debate has distracted market focus from the medium-term implications. From our perspective, ECB QE purchases will continue for many years, not through the emergency PEPP (which is due to expire in March ‘22) but through the likely reinvigorated APP programme which has been running throughout and which will run for a long time after the expiry of the PEPP.

This brings us back to a phrase which we have not used for a while and that is ‘pre-existing conditions’. Going into the pandemic, the US economy was strong, the Fed Funds rate was well above 2% and the labour market was at (or even on some measures below) full employment. In Europe rates were already at -0.50% on a persistent demand led inflation shortfall.

Over coming months and quarters, we envisage a significant widening of monetary policy dynamics (especially post the re-nomination of the current Fed Chair- allowing him greater flexibility to be more hawkish) between the US and the eurozone and widening rate differentials. The recent rally in EURUSD in our view is a bounce amid a downtrend. A trend that, like Margaret Thatcher, is not for turning (at least not yet) - heading for 1.13.

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