A confluence of events and policy shifts has coalesced into a unique opportunity for the U.K. government and U.K. firms to make long-term strategic investments.
The cost of new debt – when taken on at today’s extremely low interest rates and then adjusted for inflation – will be negative over the life of the debt. This implies that fiscal and monetary policy are creating the conditions for the next phase of the digital revolution.
The zero interest rate policy and government’s fiscal relief underscore the chance for U.K. middle market firms to pull forward a decade of productivity-enhancing investments into the next two years.
More important, firms should undertake productivity-enhancing investments this year to prepare for the intense competition that will characterize both the post-Brexit and post-pandemic global economy.
Within that global economy, countries will need to have built the physical infrastructure required for the free flow of business and to have invested in the framework for an educated workforce that can nimbly adapt to changing technologies.
The time to act is now.
Keep in mind, however, that the fiscal packages offered so far by the government are relief packages, which are necessary to keep families and businesses afloat. As essential as they are, they are not infrastructure programs and so they fall short of preparing an economy for the future.
Though it is perfectly logical for governments to directly address the immediate problems of the pandemic, we should keep in mind that it could become politically difficult to win approval for infrastructure spending once arguments that favor austerity set in again. (The paucity of growth and the rising discontent during the years of austerity following the financial crisis serve as a powerful reminder of the consequences of not investing in the future.)
Through conversations with our clients, we know that firms are acting to integrate advanced technology into the production of goods and provision of services in a manner that has not characterized middle market firms in the past.
RSM UK chief executive Rob Donaldson said that that to compete in the post-pandemic economy, firms should pull forward investments in software, equipment and intellectual property – which might normally have occurred over the decade – into the next 12 to 24 months.
The increase in personal savings during the pandemic suggests a surplus of pent-up demand waiting to be unleashed on the local economies and the global supply chain that supports them. U.K. firms should make it a point of meeting that rush of consumer spending.
Moreover, given the shape of the yield curve and negative real interest rates, an increase in business spending, especially on productivity-enhancing projects, makes economic sense and will bolster the long-term prospects of firms that have the foresight to act now.
Over the past decade, a low central bank policy rate, along with reduced expectations for growth and inflation, have pressured the entire yield curve lower.
With the yield on gilts out to a 10-year maturity at less than 0.5% and with the inflation rate running at roughly 0.5%, inflation-adjusted yields of government bonds out to a 10-year maturity are negative. That is, over the next 10 years, debt will be retired in deflated pounds, assuming that the inflation rate remains above 0.5% per year.
For the government and for private investment, financing through additional debt has the potential to pay for itself.
Though this would sound ridiculous in normal times, these times are anything but. Because of the unique confluence of events recently, there is the ability to actually make money by borrowing, because we are operating at near-zero nominal interest rates that become negative when adjusted for inflation.
We are assuming corporate borrowing at roughly 100 basis points higher than the yield on government-backed securities.
Over the life of a 10-year bond issued at 1.5%, the interest payments on a million-sterling bond would total £15,000 per year. But those payments would be deflated by the rate of inflation so that the total cost of retiring the bond after 10 years would be £950,000, assuming the inflation rate reaches the Bank of England’s 2% inflation target.
With the Bank of England anchoring the front end of the yield curve with a zero policy rate, the next few years will be defined by inflation-adjusted interest rates that are negative.
This provides a tremendous opportunity for firms to make transformational investments to complement the new era of technology, telework and automation.
Fortune favors the bold. Now is the time to act. Those firms that choose to invest in their technology and personnel will create the conditions to thrive in the coming economic expansion.
The damage wrought by the pandemic almost assures that monetary policy will continue to be directed at dampening the long end of the yield curve in the coming year. The Bank of England has added to this accommodative policy with its purchase of £875 billion of government bonds, as well as buying £20 billion of sterling nonfinancial investment-grade corporate bonds.
The central bank’s commitment to keeping short-term interest rates at the zero lower bound for as long as necessary implies that the cost of borrowing at the long end of the yield curve will remain low in nominal terms and remain negative in inflation-adjusted (or real) terms.
The takeaway
The potential return on investment amid negative real interest rates demands that firms act boldly to integrate advanced technologies into the production of goods and provision of services to prepare for what will be a very different economic and financial landscape than before the pandemic.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
