UK Austerity Message and Sterling Losing Appeal

“It’s the brave action of this government that has lifted our country out of the danger zone,” said UK Prime Minister David Cameron in a speech in the northern city of Manchester on Monday.

David Cameron
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David Cameron

Cameron was attempting to sell austerity measures to a sceptical North of England ahead of a referendum on voting reform that could put his coalition government under further pressure.

The problem with this message from Cameron and his coalition government is the data just keeps getting worse.

Overnight, the British Retail Consortium said retail sales for March fell at their fastest rate in 6 yearsas a separate report showed the housing market remains under considerable pressure.

Throw in an inflation rate of more than 4 percentand you could be forgiven for asking if the UK is heading towards stagflation following the contraction in growth in the fourth quarter and fears that austerity cuts will limit growth for at least another 18-24 months.

The problem of weaker growth and higher inflation creates major problems for Cameron and the Governor of the Bank of England, Mervyn King.

King has to make a decision on whether to try and curb rising inflation via a rate hike, mirroring Jean-Claude Trichet’s move last week in the euro zone.

The decision by the ECB is putting significant pressure on the BoE but could actually help curb inflation and boost exports according to one economist who is beginning to suspect the UK central bank will keep rates on hold.

“In the hypothetical but very likely scenario we are considering, the euro would tend to appreciate against the currencies of all countries where central banks were maintaining an ultra-accommodative monetary stance,” said Stephen Lewis, the chief economist at Monument Securities.

“There is a chance, therefore, that in these circumstances, sterling would appreciate against the US currency and this would help to cushion the fall in the pound’s effective rate,” he said. “Indeed, the UK authorities might welcome a combination of sterling weakness against the euro, boosting UK competitiveness in the euro zone, and strength against the US dollar, helping to curb cost increases for dollar-priced commodities.”

This could of course lead to higher inflation being imported from the euro zone, which is the UK’s biggest trading partner by far, but the conundrum of poor data and stubbornly high inflation will be making the decision over whether to hike or holdvery difficult for King and the Monetary Policy Committee.

On the political front, the UK is getting ready for local elections and the poll on a new voting system.

Cameron and his advisors understand the vote could put pressure on the coalition government and are attempting to sell the British people on the long-term benefits of austerity at a time when the benefits of such measures are failing to turn things around in Greece, Ireland or Portugal.

Having been forced by his advisors to take his wife on holiday on an Ryanair flight to Spain where he spent a number of days being chased by reporters around his 3 Star hotel, the Prime Minister returned from holiday to a mini heat wave this week.

He will have hoped the first sun of the year has convinced the British consumer to spend some cash but must fear that his austerity measures, which came into effect on ‘worse off Wednesday’ last week will really begin to bite in the coming weeks and months.

Cameron always knew this moment would come but as he campaigns against a new voting system which his coalition Liberal Democrat partners support, he must be worried that his coalition could come under significant threat if Nick Clegg and his team fail to achieve one of their key aims when joining the government last May.

Already the Liberal Democrats' rank and file are asking what is in the coalition for them. Another failure following losses on student loans and banking reform could further hit their poll ratings and see them questioning whether being in government is worth the loss in popularity with voters.

“In under eleven months we have shown the whole world that Britain is heading back into the black – and back in business. Confidence is growing. Our credit rating has been assured. Market interest rates have fallen. The plan on our economy is right – and we are sticking to it,” said the Prime Minister.

The data is beginning to undermine this message and the PR-conscious Prime Minister might need to start the search for the new one, unless the UK’s luck turns soon.