There was much to applaud in the Chancellor’s Mansion House speech last Thursday. It built upon her Budget message that the UK has under invested over a prolonged period of time and that things need to change.
The language was business friendly and recognised the importance of services to the economy – especially financial services. There was also a nod to Europe, a sentiment reinforced by the Bank of England Governor, with recognition of the high degree of economic inter-connection. As regards regulation, one line had particular resonance: “the UK has been regulating for risk, but not regulating for growth.” With growth being reference over forty times, this was a clear message – we have to get a better balance in our approach to risk taking. At a parochial level it was good to see the recognition of Royal London’s contribution to the Mutual Council.
To stimulate growth the government is to merge local government pension schemes (LGPS) and mandate the consolidation of smaller private sector defined contribution (DC) funds. The greater scale is projected to encourage more risk taking, particularly in relation to infrastructure investment where an additional £80bn investment is mooted as possible. Comparisons with pension schemes in Australia and Canada are used to justify these claims.
A growth agenda is a laudable objective but I’m not sure that the pension proposals are a cure. The comparison with Australia and Canada is not fair. The elephant in the room is unfunded public sector pensions. If the solution was the creation of a handful of large pension schemes covering all public sector employees, then it would be an appropriate comparison – but this is not on the table. There are no proposals to change the current Pay As You Go (PAYG) system in the public sector. This is what Canada did last century and we rejected as too disruptive. The second issue is that the Chancellor’s approach assumes higher returns can be achieved. But where is the evidence that that mega schemes will outperform the merely giant funds? After all, the consolidation within LGPS over the last decade has already produced some of the largest UK investors. But the third, and most important consideration, is that it is not government’s money. Mandating DC consolidation and setting expectation of more domestic investment sits uneasily with trustees’ fiducial responsibilities. It may be argued that the government provide beneficial taxation of pension contributions but in my view that does not merit this level of intrusion. The approach reflects an unproven belief that big is better and mega is better still. A true Canadian solution would see the creation of mega funds to include all of the public sector – that surely would be a better reflection of the big is better mantra. As it is, we pretend that our debt to GDP ratio is around 100%, when in reality it is materially higher due to unfunded pensions.
From a growth perspective, the new government has got off to a poor start. Unemployment ticked up last month and Q3 GDP barely rose – with September output being noticeably weak. Behind the figures the details are less discouraging. Real pay growth remains robust and several service sectors saw higher activity in September. Indeed, at an expenditure level, consumer, government, and investment spending were all up on the quarter. Exports, however, were a drag. Overall, the weak headline data is not enough to shift the dial on the Bank of England policy of cutting rates in a gradual manner.
“The weak headline data is not enough to shift the dial on the Bank of England policy of cutting rates”
Government bond yields were higher over the week. In the UK, 10-year rates closed around 4.5%, up 5bps whilst the US equivalent settled above 4.4%. Despite the political turmoil in Germany, there was little movement in euro yields and the French premium remained around 0.7%. Credit spreads continued to ride out volatility in government markets, with both investment grade and high yields spreads staying around year lows.
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