The beginning of the age of austerity leaves markets cautiously optimistic

Kathleen Brooks
THE markets’ wait to hear more details of exactly where the axe will fall on public spending has come to an end. Yesterday chancellor George Osborne kicked off the “age of austerity” with a list of £6.2bn in cuts for this fiscal year.

But due to the extent of the shortfall in the UK’s public finances, £6.2bn (and it’s actually more like £5bn) was a mere drop in the ocean and markets reacted as such. The pound and the FTSE 100 both remained fairly muted in trading yesterday. Sterling remained flat against the US dollar and moved less than 1 per cent up against the euro. Likewise, the FTSE 100 closed down 60 points. And the market is likely to trade with a more cautious tone in the coming weeks before the emergency budget on 22 June.

But analysts are in broad agreement that Osborne’s speech was a move in the right direction. “I think that the markets are happy with the start that has been made,” says Jeremy Batstone-Carr, director of research at Charles Stanley, the stockbroker. “We are only in the foothills of where we need to get to, however in announcing cuts already the administration has shown its support towards cutting the deficit, which will be broadly welcomed by investors.”

The muted reaction in the markets highlights the enormity of the actions that need to be taken in order to bring the UK’s public finances back under control. And there are some potential stumbling blocks along the way that might de-rail progress.

One such stumbling block could be higher taxes. If they hinder economic growth then investors are likely to flee UK assets. Simon Ward, chief economist at Henderson, the asset manager, says that although we have some detail about the cuts to public spending, we still don’t know the specific plans for expected tax hikes. “Although cutting spending is good, what they do on the tax side could offset some of the benefits,” he says. “The task for the government now is to tighten fiscal policy without targeting private sector growth.”

Although Batstone-Carr says that the markets have broadly welcomed more detail on how the UK will address its fiscal shortfall, he says that they still remain nervous. He notes that Vince Cable, a Liberal Democrat, heads the Department of Business, which faces the largest cuts of all government departments, while Conservative areas of control, for example healthcare and defence, have been spared from sharp cuts. If the Liberal Democrats rebel against this and de-stabilize the coalition then UK assets would be sold off across the board.

This highlights the balancing act that our politicians will have to achieve to keep the electorate and the markets happy in the coming months.

But for now UK markets remain at the mercy of global risk appetite. Henderson’s Ward notes that lots of things are affecting the financial markets. Investors have become unnerved by events going on in Greece and the threat of contagion to other weak economies of Europe, and they are worried by a slowdown in China. “That is why we are not seeing much of a response in terms of UK assets to the chancellor’s speech,” he says. “If we continue to see progress on the spending front then sterling, especially, will gain credit in the coming months.”

For now, though, the markets remain in wait and see mode.