In the UK, the economy looks pretty horrible, as does the Conservative government’s position in the opinion polls.

As with the Fed, it is likely to be a little while yet before rates can be cut in the UK. But rather than focus on the economic case for rate cuts or the impact on the economy when cuts start to happen, we want to focus on the political implications of monetary policy given that the US holds a presidential election in November, while the UK could hold a general election in the same month.

UK and US policy rates might be just about at the same level, but, from a political standpoint, their impact on the economy puts them worlds apart. In the US, President Biden appears deeply unpopular, in spite of the fact that the economy seems to be doing well. In the UK, the economy looks pretty horrible, as does the Conservative government’s position in the opinion polls. Is there a lesson from this?

For the US, Mr. Steve Barrow, Head of Standard Bank G10 Strategy said it would be that economic performance is not key to electoral success. For the UK Conservatives, the message might be that even if the BoE cuts rates and government policy somehow revives the economy, it can’t be guaranteed that election success will follow. But this won’t stop the Conservatives from trying. The March budget is expected to see the government try to goose the economy some more, just as it did with national insurance cuts in last year’s Autumn Statement. It might seem that there’s a limit  to this pump-priming.

After all, we all saw what happened to the gilt market and the pound when former Chancellor Kwasi Kwarteng announced large unfunded tax cuts in the September 2022 mini-budget. Unlike Kwarteng, current Chancellor Hunt does allow the independent Office for Budget Responsibility (OBR) to provide forecasts based on government plans. But while that might make it seem that lessons have been learned and that no such fiscal largesse can be delivered again, the government knows that all it need do to generate so called ‘fiscal headroom’ to lower taxes is to project that public spending will fall sharply in the future; a sort of reverse jam-tomorrow policy.

The OBR has no choice but to accept these spending projections at face value and project future budgets accordingly. By calibrating the right level of future spending, the government can stick to its budget rules, as per the OBR forecasts, and also cut taxes. The OBR itself has criticised this practice. Its head, Richard Hughes said the following: “Some people call a work of fiction, but that is probably being generous when someone has bothered to write a work of fiction.”. The IMF also weighed in earlier this week with its Chief Economist Gourinchas saying that the Chancellor should not cut taxes but, instead, use any spare cash to reduce the deficit. But this is an election year. The Conservatives are more than 20-points behind in the polls. So, it is not going to happen. The question is whether the market is willing to have the wool continually pulled over its eyes in this way. The September 2022 debacle under Kwarteng might suggest that the market is not willing to do so. Back then, gilts crashed, the pound fell, the BoE had to buy gilts, and it cost the Chancellor his job as well as that of his boss, former PM Truss.

However, as many have said before, the September 2022 crisis was primarily a function of vulnerabilities in the defined benefit pension sector and particularly the Liability Driven Investment (LDI) sector. Mr. Steve Barrow doubts that these same vulnerabilities will exist, or at least not to the same extent. Hence, the government can indeed continue to pull the wool over the market’s eyes with ‘fictional’ spending projections for the future. Chances are, of course, that it will be up to the new government, which is likely to be the Labour opposition, to deal with the prospect of draconian spending cuts, not the Conservatives. Could this give the Chancellor even more incentive to push the boat out on tax cuts now? Possibly, although recent comments from Hunt might suggest that he is stretching the elastic a bit far here and, if it snaps back to create anything like the September 2022 carnage, it could be curtains for the Conservatives in future elections, not just this one.