What President Trump’s first 100 days point for the UK economy.
The latest elections results in France got investors and Europhiles excited about the prospects for a stronger Europe and a reformed France. But while Emmanuel Macron won a landslide victory in the presidential elections, the winner of the parliamentary elections in June is less clear and will influence Macron’s ability to enact his programme.
We have seen only across the pond how hard it can be to translate elections promises to concrete legislation, even when the president commands a majority in the legislative bodies and as the Trump administration passed its first 100 days in office, the impact of its plans could be relatively limited for the UK economy.
The increase in Treasury yields at the end of 2016 indicated a possible increase in inflation over the next 10 years. Some analysts linked this to the plans of the new administration for a fiscal stimulus, needed to underwrite a rise in infrastructure investment or a series of tax cuts.
And yet the implied inflation rate is not particularly high by historic standards, merely returning to values seen as recently as 2014. It could be a reflection of a normalisation of monetary policy by the Federal Reserve, that may well have occurred regardless of who became president. Any knock-on effect for the UK is therefore limited, as of now.
Far more significant for the UK may be the future course of monetary policy set by the Fed. With Janet Yellen stepping down as Fed chairwoman at the beginning of 2018, some believe her replacement may well have a more hawkish take on US policy. The same may also be true of the four new members of the Federal Open Market Committee (FOMC) board who President Trump will need to appoint to fill current vacancies.
What does that imply for the UK? In essence, faster rate rises and less tolerance for higher inflation fluctuations in the US would lead to a stronger US dollar – and, therefore, a relatively weaker pound.
The UK could be even more profoundly affected, if the Trump administration pushes ahead with plans announced in April to slash corporation tax to 15% (State taxes are typically 4-5%, so the total effective rate will usually be higher). At present, the UK is seen as a more attractive destination for investors due to its 20% rate versus 35% in the US.
While the effective rate of tax for US corporations actually stands at just over 22% (because of complexities in the current tax code) many companies have shifted their tax footprint outside the US, much to the UK’s benefit.
The high statutory rate of tax has encouraged US multinationals to shrink the volume of their US revenues, in favour of their foreign subsidiaries. Likewise, we’ve seen mergers with smaller foreign companies for the purpose of reducing tax liabilities known as tax inversions, such as the takeover of Pace by Arris. Could we now see a reversal of tax-induced flows towards the UK?
The revenues earned by US companies from their Foreign Direct Investment (FDI) activities is significant, with quarterly levels of reinvested earnings by US companies reaching US$77 billion globally, and income from FDI activities in the UK reaching US$10 billion.
Should US companies be wooed back to the US by significantly lower corporation taxes (The introduction of a border adjustment tax may make the impact significantly higher) that development could represent an appreciable dent to the UK’s levels of inward investment.
Equally, if President Trump announced an amnesty on the repatriation of foreign profits, FDI into destinations including Britain could fall significantly. Companies have been stockpiling earnings abroad since the last “tax holiday” passed in 2004 in the hope of another. On that occasion FDI by US companies fell by 216% as they brought money home. Details are not yet clear, but hints from the White House suggest another may be on the way.
There has also been talk of a shift to a territorial tax system, which would make US businesses liable only for tax on earnings in the US. Again, it’s very early days for this proposal and, as yet, too soon to assess the likely effect on the UK.
As the world’s largest economy, changes in US policy inevitably reverberate the world over. However, the first 100 days of the new administration have not produced any radical changes so far. Although a substantial reform of the US corporate tax system could result in a major blow to inward investment, in the years to come we believe that domestic policy shocks are likely to shape the UK economy far more profoundly.