OBR ‘erring on the side of caution’, says EY ITEM Club
Howard Archer, chief economic advisor to the EY ITEM Club, comments on the Chancellor’s Budget.
There are pretty dramatic downgrades to the UK GDP growth forecasts by the Office for Budget Responsibility (OBR) in the Budget. The 2017 GDP growth forecast has been cut from 2.0% to 1.5% (which is largely baked in given that data has been released for the first three quarters) while the 2018 projection has been cut from 1.6% to 1.4%. These new forecasts match the current EY ITEM Club projections.
It seems that the OBR may now be erring on the side of caution on UK productivity growth, having been repeatedly over-optimistic in recent years. Obviously, the longer-term UK GDP growth forecasts will be substantially influenced by Brexit developments, however the productivity expectations may now be overly pessimistic.
Specifically, the OBR has cut forecast UK GDP growth to just 1.3% in both 2019 and 2020, rising to 1.5% in 2021 and 1.6% in 2022. This means that at no stage over the period through to 2022 does the UK see growth of 2.0% - indeed it struggles to grow by more than 1.5%. Previously, the OBR had expected growth to be 1.7% in 2019, 1.9% in 2020 and 2.0% in 2021.
The OBR has repeatedly assumed in recent years that there will be a marked pick-up in the UK’s productivity performance, but this has failed to materialize. Consequently, the OBR has now come to the conclusion that some of the temporary factors that it believed were holding back productivity are having a permanent impact. Back in March, the OBR forecast that productivity growth (output per hour worked) would rise from 1.4% in 2017 to 1.5% in 2018 and then get up to 1.8% in 2020 and 2021. Now the OBR expects productivity growth to be just 0.9% in 2017 dipping to 0.7% in 2018 before rising gradually to 1.1% in 2021 and 1.2% in 2022. These forecasts look very cautious to us. The marked downward revisions to productivity growth are also only modestly countered by the OBR cutting its estimation of the UK’s equilibrium unemployment rate from 5.0% to 4.5%.
As a consequence of the lower GDP forecasts over the medium-term, the expected budget shortfalls (Public Sector Net Borrowing excluding banks – PSNBex) have been revised up significantly. This is despite the near-term PSNBex projections being cut due to the much lower-than-expected shortfalls over the first seven months of fiscal year 2017/18. Specifically, PSNBex in 2017/18 is now expected to come in at £49.9 billion rather than £58.3 billion - a reduction of £8.4 billion. The expected shortfall in 2019/20 has also been edged down to £39.5 billion from £40.8 billion.
However, with the longer-term GDP growth forecasts cut markedly, the Chancellor is now expected to have a budget deficit of £32.8 billion instead of £20.6 billion in 2020/2. It is still expected to be as high as £25.6 billion in 2022/23. This means that the Chancellor would still achieve his target of getting the cyclically-adjusted budget deficit below 2.0% of GDP in 2021/22, although he would have a buffer of around £13 billion instead of £26 billion. With an expected budget deficit of £25.6 billion in 2022/23, it also looks increasingly questionable as to whether the Chancellor will be able to get the budget into balance by the middle of the next decade.
In terms of the overall fiscal stance, the Budget is simulative in the near-term. Specifically, the OBR observes that the Government’s measures “adds £2.7 billion to borrowing next year and a larger £9.2 billion (0.4 per cent of GDP) in 2019-20.
The Chancellor has stuck to his fiscal targets and delivered a pretty low-key budget overall. Given the major uncertainties facing the economy, the Chancellor is clearly concerned that investor confidence in the UK could be damaged if he abandons the fiscal framework that was adopted only a year ago. It is also likely that the Chancellor wants to keep some room for manoeuvre should the economy suffer a slowdown over the coming years as the Brexit process develops.