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George Osborne has just stepped off the podium at the Houses of Parliament and the main message he delivered during his autumn statement was that for the Chancellor of the Exchequer there is only a plan A, plan B is not an option when it comes to getting the UK's finances back under control. No doubt the autumn budget statement had more of a wintry feel to it, but Osborne is sticking to his guns and while he resides at 11 Downing Street he will do his best to make sure that the UK does not lose its triple A credit rating.

Autumn statement 2011: highlights
· The Office for Budget responsibility has cut its growth forecast to 0.9% for this year from 1.7% in the March budget and to 0.7% next year, down from the March forecast of 2.5%.
· The OBR doesn't expect the UK to fall in to recession although Osborne admits this is a risk as the Eurozone continues to wallow in its debt crisis.
· Weak growth means that our debt problem is going to take longer to sort out than first thought. Osborne had prepped us for the slippage in bringing the budget deficit back to balance from 2014/15 to 2016/17. The OBR said that more of the UK's deficit is structural rather than cyclical, which will take major social changes and cuts to spending to fix. So the UK's economy isn't going to be able to grow its way out of this crisis - austerity is the only cure. This is the same for many European countries and the US.
· The effect of slow growth has already impacted borrowing forecasts, which are expected to be higher than expected this year and next. The deficit for the financial year ending March 2013 will be GBP120bn, compared with GBP101bn forecast in March. This is a near 20% increase and is extremely worrying. It highlights the mountain the UK has to climb to get its finances back under control.
· Osborne made it clear: the headroom we thought we had to achieve fiscal goals a year early has now disappeared. However, some fear that his growth forecasts are too optimistic and if we do fall back into recession then even more fiscal slippage will swiftly follow.
· The Chancellor shifted the debate on spending cuts and austerity by saying that a rise in interest rates is worse for households and families than spending cuts. This is important as it is a direct message to the markets that Osborne is doing everything he can to stick to plan A.
· Public sector pay rises will only be in the region of 1% after the pay freeze ends in 2013 - Osborne is playing hard ball with the public sector unions, he also called on public sector workers to call off tomorrow's general strike, which is likely to fall on deaf ears.
· Government spending is set to fall 0.9% per year from 2015 on top of the GBP80bn of cuts already planned.
· The state pension age is to rise to 67 from 65 in 2026 - I think this should rise now as we are all living longer; delaying it is a political tactic since this is an explosive issue even 2.5 years before the next general election. However, the country needs to save money now and Osborne's comments here were definitely a disappointment.
· His giveaway was a bit like the Grinch at Christmas. Lots of long-term initiatives on home ownership and boosting the construction sector, but little in terms of near-term action.
· There were some positive initiatives to improve access to funding for small businesses. Credit easing for small firms was confirmed and the national loan guarantee scheme will use low government borrowing costs to lend to businesses at low rates. Businesses with less than GBP 50 mn of annual turnover are eligible, Osborne predicts this should reduce average lending rates by 1%, which is a positive move.

Market reaction:
As usual with these types of speeches we had been prepped for weeks that Osborne would lash on the gloom, so a lot of it was priced in already. Thus, we saw Gilt yields and sterling remain steady during his speech. Interestingly, the pound started to fall and Gilt yields started to rise as the Shadow Chancellor Ed Balls took to the podium. This could be coincidence, but Balls' speech is particularly anti-market and his plan to slow down austerity measures and try to borrow our way to boost growth doesn't deal with the real issue: our completely unsustainable structural deficit that the Labour party helped to create during its 13 years in office.

However, to give Balls some credit, his speech started at the same time as reports surfaced that students had stormed the British embassy in Tehran, and by the end of his speech Gilt yields had started to turn lower.

However, overall this was a market-friendly speech from Osborne that is likely to continue to fuel safe haven demand to the UK bond market, which should prop up the pound especially versus the dollar and the euro. Added to that there were some positive policy changes to boost business, which should also be GBP supportive, even if the intra-day driver of the pound is still overall risk appetite.

Overall this was one of the most realistic budgets that we have had in the UK for years. The Chancellor was almost overly gloomy, getting all of the bad news out: lower growth, higher borrowing etc. However, in this uncertain environment the Chancellor is playing a dangerous game as things could get much worse for the UK and there is a real chance that he may have revise things even lower in March at the next Budget.

Added to this Osborne could have been bolder in some areas such as the state pension age, although he is likely to be applauded for his moves regarding public sector spending and wage increases.

Overall, this was a gloomy statement that didn't try and sugar-coat the UK's predicament. However, the Chancellor's commitment to fiscal austerity is likely to keep Gilt yields low, which may support the pound.

But in the shorter-term tomorrow's public sector strike may weigh negatively on the pound since it highlights the social opposition to the Chancellor's plans, which could knock the programme off track. Right now we are not at this point, but things can deteriorate very quickly and all eyes will be on tomorrow.

This pair has suffered today after it was announced that the ECB had failed to sterilise all of its bond purchases last week. This spurred speculation the ECB was softening its stance towards QE, which is a big negative for the single currency. However, although we believe that it is too early to say that QE is on the cards for the ECB, it caused EURGBP to break below 0.8550 - a key support level. In the past this cross hasn't been able to break below 0.8550 - but if there are steps towards QE this could cause this support zone to be breached also. We believe the pair will continue to weaken towards the 0.8500 support, and could trade in a choppy 0.85 to 0.86 range in the lead-up to the EU leaders summit on 9th December.

Added to this, George Osborne's autumn statement today confirmed the UK's commitment to fiscal consolidation, which is likely to continue to attract safe haven flow to UK Gilt yields, which is also supportive of the pound versus the single currency.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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