Sunak's Spending Boost Could Yet Benefit the Pound

• UK GDP to be boosted by £15BN giveaway
• Could shore up consumer confidence
• And turn tide on negative economic impulse
• Ultimately offering GBP support
• But windfall tax a big red tick against GBP says HSBC

Above: File image of Rishi Sunak. Image © Pound Sterling Live, Image courtesy of Parliament.tv

The British Pound would likely benefit against the Euro and Dollar if Chancellor Rishi Sunak's £15BN cash giveaway results in a boost to UK consumer confidence over coming weeks.

Sunak announced the extra spending would be made available to households struggling under the weight of the rising cost of living and economists say the measures should therefore boost economic growth.

The economics consultancy Capital Economics estimates UK GDP growth will be stronger to the tune of about 0.2-0.3 percentage points.

Analysts at Investec and Pantheon Macroeconomics meanwhile say the cash boost significantly lowers the risk the UK economy falls into recession.

Above: "The Chancellor's measures are hefty, targeted and timely." - Pantheon Macroeconomics.

But inflation is set to rise further as 8.4 million households will see £650 airdropped into their bank accounts which complicates the economic outlook given the cost of living crisis is in effect a crisis of inflation.

Sunak acknowledged to Parliament the measures would inevitably boost inflation rates, although he believed the additional impulse was "manageable".

The additional inflationary pressures will meanwhile only place further pressure on the Bank of England to hike interest rates.

Capital Economics estimates, other things being equal, this loosening in fiscal policy means that to bring inflation back down to the 2% target monetary policy will need to be tighter.

This support their view that the Bank of England will have to raise interest rates from 1.00% now to 3.00% next year.

Above: One in five Britons now say they are struggling or unable to make ends meet. Sunak's cash will be welcomed most by 8 million of the least well off households.

The Pound has fallen sharply during May with analysts blaming the declines on surging inflation, falling economic growth, plummeting consumer confidence and the Bank of England's apparent unwillingness to raise interest rates aggressively.

It therefore stands that the currency could benefit if UK data were to start surprising to the upside again in coming months, shoring up expectations for further Bank of England interest rate hikes.

"On the positive side, the extra help being offered to a range of consumers should alleviate at least a portion of the increasing cost of living pressures that have been threatening to drag growth lower," says Dominic Bunning, Head of European FX Research, HSBC Bank plc.

The UK consumer's response will be particularly important going forward. GfK’s long-running Consumer Confidence Index decreased two points to -40 in May, the lowest score since records began in 1974.

This matters for the UK economy given it is driven by its consumer facing services sector.

What's good for consumer confidence is therefore good for the economy and, by extension, the Pound.

Above: GfK's consumer confidence measure is at all time lows. Can Sunak's cash boost rescue sentiment?

But the economic surveys covering any shifts in sentiment and consumer behaviour following the Chancellors announcements are still at least a month away, meaning the tide of deteriorating sentiment towards the UK and the Pound is yet to turn.

"GBP is being pushed and pulled by the government’s latest policy announcements regarding the energy sector, with potentially positive cyclical signals battling against contrastingly negative structural ones," says Bunning.

Some negatives identified by Bunning include the anti-business nature of a windfall tax placed on energy producers and a further deterioration in the UK's debt position.

"Until it is clearer how this new fiscal policy interacts with monetary policy, GBP may struggle for direction, in our view," he says.

Kamal Sharma, FX Strategist at Bank of America Merrill Lynch says he does not believe Sunak's stimulus package marks a game-changing event for Sterling.

"We do not think that the GBP will be able to extract much juice from a further pivot in UK rates," says Sharma. "Some of the headwinds to the UK economy may have been alleviated, but we doubt that this announcement is a decisive moment in the UK growth dynamic."

HSBC's Bunning says the tax on energy producers is a particular negative for the Pound as rising taxes and inconsistent tax policy "might weaken foreign investor sentiment towards the UK".

After all, why would the government stop at energy companies? In the future any sector making handsome profits might be targeted confirming that what matters from a longer term perspective is sentiment.

If the Conservatives are happy to introduce random tax hikes a future Labour government would do so with zeal.

Incoming international investor capital is a crucial pillar for the Pound's valuations: "facing a still large current account deficit, any softening in capital inflows from overseas creates downward pressure for GBP," says Bunning.

The Pound's initial reaction to the announcement reflects the apparent push and pull factors at play from a currency perspective: the Pound to Euro exchange rate was lower by a third of a percent in the hours following the announcement but the Pound to Dollar was higher.

In fact the moves were entirely consistent with a broadly stronger Euro (the outperformer of the day) and a broadly weaker Dollar with little idiosyncratic forces moving Sterling.

Therefore the near-term impact of Sunak's giveaway is negligible but the end of June could be when some positive surprises in the economic data start filtering through and offer the Pound some support.