UK public finances after Brexit – how should the Chancellor respond?
15 November 2016
We live in turbulent times, with the outcome of the US Presidential election throwing further political uncertainty into the mix. But so far the Brexit vote has not had a major negative effect on UK economic growth, with consumer spending and services holding up well over the summer and early autumn.
It is still early days though and, in our latest UK Economic Outlook report, we project that uncertainty related to Brexit will lead to a gradual slowdown in GDP growth from around 2% this year to around 1.2% in 2017. This is driven primarily by a decline in business investment, but also by a squeeze on real household spending power as the weak pound pushes up inflation to around 2.7% by the end of 2017.
All UK regions are expected to see lower growth next year, though none is projected to fall into recession. Generally speaking we expect Brexit to lead to a long, slow drag on UK growth over the next few years rather than a short, sharp shock.
So, with the Autumn Statement coming up on 23rd November, what does this mean for the public finances? The table below summarises our latest projections as compared to the last set of official OBR projections made back in March, which assumed (as a matter of convention not prediction) a vote to remain in the EU.
You can see from this table that the budget deficit looks like coming in well above target both this financial year and for some years to come. Indeed, adding up the overshoots, cumulative public borrowing could be around £100 billion higher over the five years to 2020/21 than the OBR forecast back in March.
Is this a fiscal disaster? Not really.
The overall budget deficit would still be less than 1% of GDP by 2019/20. The public debt to GDP ratio would still be falling by that time. And the current budget (i.e. borrowing excluding net public investment spending) would probably be back in surplus by 2019/20. This would still meet a forward-looking ‘Golden Rule’ of borrowing only to invest that would be similar to George Osborne’s original 2010 fiscal rule, rather than the tougher – and, some would argue, unnecessarily tough – alternative of achieving an outright budget surplus before 2020 that he adopted ahead of the 2015 election.
Given all of this, I would expect the Chancellor to take a pragmatic approach in his Autumn Statement, allowing borrowing to take the strain of slower growth, revising his fiscal rules to increase flexibility, and boosting housing and infrastructure investment over the next few years to soften the blow to private investment from Brexit-related uncertainty.
I suspect Mr Hammond will still aim to balance the books eventually, so this is not the end of austerity. But I’d expect the Chancellor to phase this over a longer period of time extending into the 2020s. That seems like a sensible approach to managing the economic pain associated with Brexit, while still maintaining fiscal prudence in the longer term.
For more detailed analysis of this and other economic issues, please read our latest UK Economic Outlook report. This also features a special article by Andrew Sentance, our Senior Economic Adviser, on UK trade prospects after Brexit.