Budget Alert 2013: EY ITEM Club

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Exciting would be the wrong word to use, but this Budget was much more interesting than we expected given the very weak economic background.

The Chancellor set the scene by telling us that the Office for Budget Responsibility (OBR) had halved its economic forecast for this year from 1.2% to just 0.6%. The risk was that with revenues much lower than forecast in the autumn, he would be forced to admit that the underlying measure of public borrowing would be higher than last year. However, he was let off the hook by another shortfall in this year’s public spending, which left spending £11bn below last year’s Budget.

The OBR forecast looks unduly pessimistic, particularly for the second half of this year when we expect activity to perk up. The OBR’s GDP forecast picks up after that, moving back to their previous projection. But the composition is very disappointing, with most of the growth coming from the home market rather than overseas. Net trade adds just 0.1% to GDP in each year of the forecast after subtracting 0.8% last year. OBR forecasts for housing transactions, prices and investment were all revised down despite the recent signs of life and the additional stimulus announced by the Chancellor.

Leeway for capital spending on infrastructure and housing will come from further restraint on current spending, within a fiscally neutral stance. The departmental detail will be thrashed out in the spending review in June.  These departmental savings are augmented by another £6bn of savings that the single state pension will bring. Switching from current to capital spending has the effect of reducing the current deficit and helping to ease the pressure on the Government’s main fiscal target.

£3bn of these savings will be used to boost infrastructure spending. However, the really big boost will come from the £5.4bn housing market package. These funds will be geared up so that they have a major impact, in a sector that has a lot of pent up demand held back by a lack of mortgage finance. There is a lot of spare capacity in the construction industry, which is very important for demand and employment given its low import propensity.

The £3.5bn allocated to shared equity loans under the ‘help to buy’ scheme may not sound like very much but the impact on housing transactions should be five times bigger because the Government share of the purchase price is at most 20%. Similarly, the £1.9bn mortgage guarantee scheme uses the strength of the Government’s standing in debt markets to provide a much larger boost.  These initiatives reinforce the effect of last year’s Funding for Lending Scheme which has already leveraged the Government’s balance sheet to provide a major support for housing and the wider economy.

We are likely to see more of these financial initiatives and innovations when the new Governor of the Bank of England arrives and the new monetary policy remit comes into play. The idea is to take a leaf or two out of the US Fed’s book by announcing intermediate thresholds for economic growth and employment while preserving the primacy of the inflation target over the medium term. This new approach will give the new Governor and the Monetary Policy Committee (MPC) the flexibility they need to support the real economy without endangering the credibility of the monetary policy framework in the way that just allowing inflation to overshoot currently does. In the same way that inflation target originally provided reassurance about inflation, intermediate thresholds for the real economy should give people some reassurance about the outlook for output and employment, realising that the MPC was likely to take action to offset any serious weakness.

All in all, this Budget should help lift the gloom of a very bleak economic backdrop.

"Changes in Corporation Tax and NI Contributions are welcomed. The housing initiatives should stimulate construction and improve the consumer outlook while the new monetary policy regime suggests that the authorities will intervene if necessary. However, the reduction in the growth outlook means that businesses are likely to remain in wait and see mode and the OBR's forecast of low business investment growth in 2013 is likely to be self fulfilling."
Mark Gregory, EY Chief Economist.