Today the Chancellor Philip Hammond presented his first Spring Statement in which he updated us on latest developments in the economy and the public finances. This Statement is in place of the annual Budget which is now occurring in the autumn. Here is our assessment of today’s Statement.
The economic message in the Spring Statement was a positive one, and rightly so.
First, the government’s finances are improving at a faster pace than either officials or the markets expected. This is a trend that looks set to continue. Last spring the official forecast was for borrowing in 2017-18 of £58.3 billion. By the autumn the forecast was £49.9 billion. Today this figure was lowered to £45.2 billion, with a further improvement to £37.1 billion next fiscal year.
This also means that the ratio of debt to GDP is set to peak this year, at 85.6%, before declining gradually. In my view, debt dynamics could allow the fiscal numbers to improve far more than expected in coming years. This would be helped by nominal GDP, which is economic growth plus inflation, rising at a rate far higher than the level of government bond yields, which should stay low as inflation decelerates towards its 2% target.
Second, the economic numbers are improving. Real wages are expected to be rising by this summer, as higher wage growth occurs alongside falling inflation. Further good news is also expected on employment, which is expected to keep rising throughout the next five years. As the Centre for Social Justice has pointed out, employment is the best path out of poverty, so this strong jobs market is good news.
The economy grew 1.7% last year, higher than the 1.5% that the independent Office for Budget Responsibility (OBR) forecast last autumn. It also tweaked higher its growth forecast for this year to 1.5%. This is in line with average of economic forecasters but lower than the close to 2% I expect. Despite this, the OBR has kept its low forecasts unchanged for 2019 and 2020 and cut them for 2021 and 2022.
I think this is too pessimistic. Even though exports and manufacturing are being helped by the recovery in the world economy, the economy still faces some significant challenge and current growth is weak by international standards. Also, as we have highlighted for some time, growth is imbalanced.
Recurring themes in recent years in the OBR’s analysis have been low productivity growth and weak business investment. Both of these are still concerns. At least recent data has pointed to a rise in productivity growth, which should continue. Meanwhile, consumer confidence is rising, but business confidence remains low.
While uncertainty over Brexit is weighing on investment plans, sluggish investment has been a feature of the last decade. Indeed, Brexit was the elephant in the room in the Statement in that it was barely mentioned. The Chancellor acknowledged that the £3 billion set aside in preparation for a ‘No deal’ is being allocated. This is sensible planning. In coming months there is still considerable uncertainty with the focus of attention likely to be on the next phase of the UK-EU trade negotiations. By the time the Autumn Budget is delivered, it is expected that progress will have been made on a trade deal, in which case the Chancellor will hope that his focus then will be on the opportunities that Brexit can help deliver.
Third, the main policy message was that of a “balanced approach”. This makes sense. If we didn’t know it already, austerity is dead. As the budget deficit falls, the Chancellor will use his additional headroom to boost spending as well as cutting taxes gradually and banking some of the gains to lower the deficit further. So reducing the deficit is not the only focus of policy. The Shadow Chancellor’s focus in his comments on public services helps explain why.
This balanced approach is reflected in the OBR assumption that the underlying improvement in the budget deficit from 2018/19 onwards will be £3.2 billion per year with £5.8 billion per year in increased tax revenues offset by £2.6 billion higher government spending.
With the Chancellor effectively saying that fiscal policy is on auto-pilot until the Autumn Budget, the implication for monetary policy is neutral, with the Bank of England needing to be gradual and predictable in its policy actions.
Dr Gerard Lyons is Chief Economic Strategist at Netwealth Investments.