New OBR forecasts – a lucky escape for the Chancellor?
By John Hawksworth, Chief Economist
At the time of the Budget in March, the Office for Budget Responsibility (OBR) was expecting UK GDP growth to be around 1% in this year, picking up to around 3% on average in the medium term. Even at the time this looked relatively optimistic and subsequent events – notably renewed problems in the Eurozone – have caused the OBR to reduce their growth forecasts significantly (as can be seen by comparing the first two rows of the table below).
The OBR’s projections are now closer to the views of PwC and other forecasters. The downward revisions are not great news for the Chancellor but – as I explain below – there was a very important silver lining that made his task in the Autumn Statement a lot less difficult than it might have been.
Comparison of key OBR forecasts at the time of the 2012 Budget and the Autumn Statement
As the table shows, lower expected economic growth has inevitably led to lower projected tax revenues and so higher expected public borrowing. The annual budget deficit, after adjusting for special factors, is now forecast by the OBR to remain over £50 billion in 2016/17, as compared to just £21 billion in their March forecast – a difference of around 2% of GDP. The net public debt stock is now projected to peak at over 83% of GDP in 2015/16 (excluding special factors), one year later than before and at a markedly higher level compared to the 76.3% of GDP peak in 2014/15 projected back in March.
This all sounds pretty bad but crucially - and this is the silver lining - the OBR concluded that most of this deterioration in economic growth and the public finances should only be a temporary cyclical phenomenon rather than a permanent structural problem.
This means that the Chancellor’s key fiscal target – to eliminate the structural budget deficit (adjusted for the state of the economic cycle and excluding net public investment) by the end of a rolling five year forecasting period – can still be met with only a relatively small additional real public spending cut of around £5 billion in 2017/18. In macroeconomic terms this is small beer – only around 0.3% of GDP in that year.
The OBR’s assessment represented a lucky escape for the Chancellor because it avoided the need for much larger additional spending cuts or tax rises. Indeed for the next four years the Chancellor was able to present a broadly fiscally neutral package including a switch of around £5 billion from current spending to capital investment over the next two years. On the tax side, cuts in some areas (e.g. delayed fuel duty rises, a higher personal allowance and a 1% reduction in the main corporation tax rate from 2014) were balanced by tax increases elsewhere (e.g. on pension tax relief, indexation of the higher rate threshold, the bank levy and tax avoidance).
Overall, we would see the Autumn Statement package as being marginally positive for economic growth in the medium term, although the net effect will be small in macroeconomic terms given the limited funds that the Chancellor had at his disposal.
The real risk for the Chancellor though is that more of the weakness in growth and the public finances will turn out to be structural rather than cyclical. If that proves to be the case, then further tax rises or spending cuts may yet be needed to balance the books in the longer term. The Chancellor had a lucky escape this time – but will it last?
Contact: John Hawksworth | Tel: +44 (0)20 7213 1650