Leaning into growth is the right attitude

The ill temper of the London markets yesterday may in part be attributed to the Mansion House speeches of the Chancellor and the Governor of the Bank of England the night before, but the basic truth is that the markets are hunting at the moment for excuses to be glum.

In fact, the sell-off on the New York bond market on Wednesday evening was probably as large an influence as the London speeches.

The new information in the Mansion House speeches was minimal: no early cut in taxes from the Chancellor; a reminder from the Governor that interest rates would at some stage have to turn up. It is always useful to have a judgement confirmed, but everyone with any sense knew both these points.

The only new nugget of news came from the Chancellor on public spending. He said the target was to bring it below 40 per cent of gross domestic product and he hinted that spending would be tightened. But the experience of the explosion in public borrowing over the last four years should make it clear that any vague statements of intent on spending should be taken with a pinch of salt.

As for the prospective rise in base rates, some rise is explicit in the futures markets, which have been signalling base rates close to 9 per cent by the end of next year - a rate that will surely prove far too high.

The working assumption one should make from these two speeches, taken together, is that in as far as policy is biased in any one direction the instinct of both the Treasury and the Bank will be to lean against the recovery in the coming months. But that is hardly saying anything new, for the Government is not going to want to encourage too much growth at this stage of the cycle, while the Bank knows it is on trial now that it has gained a greater measure of independence.

In the absence, then, of significant new information on policy, what do we know about the backcloth for the UK investment markets at the moment?

Point one: UK public finances are probably still on the track outlined at the time of the Budget, but it is not yet reasonable to assume that the public sector borrowing requirement will significantly undershoot its target.

Despite the rather high PSBR for May at pounds 4.34bn revealed yesterday, some undershoot is still possible, for the economy this year may well grow at more than the 3 to 3.5 per cent range the market now expects. (Faster growth increases tax revenues and cuts social security spending, particularly on unemployment and associated benefits.) But there is some lag between growth in the economy and rising tax revenues, so it would be unwise to count on a much better-than-expected PSBR for the current year.

Point two follows from this. It is very hard to see growth at less than 3 per cent this year and 3.5 per cent is possible. Yesterday's figures for retail sales, which account for a big chunk of consumption, showed a 3.9 per cent year-on-year rise. Investment is now picking up sharply, averaging annualised growth at about 10 per cent since last October. So growth of consumption has to come down to make room for this, if overall GDP growth is not to head into the 4 per cent-plus region - a rate that would almost certainly lead to a sharp deterioration in the current account.

Given these two points, the fact that the bias of policy should be to lean into growth is surely right. There is, in addition, a further cause for caution from abroad.

The balance of probability is that international uncertainties will increase in the coming months.

Most obviously we still have to expect further tightening of monetary policy in the United States, with only limited scope for rate cuts in Continental Europe (though these will continue to come through in dribs and drabs).

There is also the ever-present danger of some unpredicted and indeed unpredictable shock: misbehaviour by North Korea is the current front-runner, but the shock could come from any one of half-a-dozen places.

It is pointless to plan for such events for there is no particular way investors can protect themselves. It is worth recalling, though, that even increased tension itself - the fear of a political shock - has a market impact and would need to be met with action by the world's monetary authorities.

From the authorities' point of view it is worth being cautious now so that policy can be eased, if it needs to be, at some later stage.

Meanwhile the authorities in Britain and the US (and perhaps to a lesser extent in Germany) need to rebuild trust, particularly their credibility against inflation. There is no easy way of doing this: they have to wait and show that their relative optimism is right.