Press release

28 Feb 2021 London, GB

Austerity off the agenda as Chancellor juggles continued pandemic support with long-term vision, says EY ITEM Club

Austerity off the agenda as Chancellor juggles continued pandemic support with long-term vision, says EY ITEM Club

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Related topics Growth
  • Government borrowing expected to reach 19% of GDP in 2020-21 – the highest level of borrowing since the end of World War II
  • However, EY ITEM Club says that any austerity measures should wait to avoid undermining the UK’s economic recovery
  • The EY ITEM Club also expects the Office for Budget Responsibility to deliver a mix of bad news and good in the forecast which accompanies Wednesday’s Budget, with a weaker starting point for GDP, but a stronger recovery predicted in the second half of this year

Despite record levels of Government borrowing, the Chancellor should avoid tightening fiscal policy in Wednesday’s Budget and leave consolidation until the long-term economic impact of COVID-19 is clear, the economy is recovering and room exists to cut interest rates, according to the EY ITEM Club’s Budget Preview, published today.

Instead, the EY ITEM Club says it is important the Chancellor focuses on continuing to support consumer and business confidence in the economy. This could include the extension of current support measures, policies to smooth the UK economy’s post-pandemic adjustment, and action on public investment to boost long-term growth and the Government’s levelling-up agenda.

With the Chancellor still tackling the impact of COVID-19 on the economy, the EY ITEM Club expects government borrowing to reach just under £400bn – 19% of GDP – in 2020-21, roughly in line with the Office for Budget Responsibility’s November forecast. This would be the highest level of borrowing since the end of World War II.

The EY ITEM Club also expects the Office for Budget Responsibility to downgrade its November forecast for UK GDP growth in the first quarter of 2021, while, thanks to the rapid rollout of vaccinations, anticipating a stronger recovery later this year. The EY ITEM Club expects the economy to contract by around 4% in the first quarter before growing 5% over 2021 and 6.5% in 2022.

Fiscal consolidation may have to come – but not now

Martin Beck, Senior Economic Adviser to the EY ITEM Club, says: “Despite an almost unprecedented peacetime deficit, serious action to repair the public finances can wait. The Chancellor’s focus should still be on supporting the economy through the pandemic and premature fiscal tightening could undermine recovery. With the cost of government debt still historically low, there is no evidence yet of any significant constraint on government borrowing.

“A strong consumer recovery is possible when lockdown restrictions ease given the high rate of household saving over the last year. This means an across-the-board stimulus, such as VAT and income tax cuts, is not required. But there is rationale for continued, nuanced support for businesses and key sectors. A plan for the future, which can help deliver the Government’s levelling-up agenda, is needed too.

“Fiscal consolidation may have to come at some point but should happen when there is a clearer view of the long-term economic impact of the pandemic. The future approach will depend on how much economic ‘scarring’ there has been; this won’t be obvious yet. It’s also important there is room to cut interest rates to offset the impact of tighter fiscal policy, if need be. The EY ITEM Club does not expect interest rates to rise above 0.5% until 2024, so any significant fiscal tightening might have to wait until the second half of this decade.”

The EY ITEM Club forecasts that economic recovery from the second quarter of 2021 onwards means the UK’s deficit should, excluding new budget measures, fall to 7.2% of GDP in 2021-22 – a lower level than was seen at the height of the previous decade’s financial crisis, and a fall of two-thirds from this year’s level.

Chancellor expected to set out path to post-COVID economy

Now the Government has set out a path to easing pandemic-related restrictions, the EY ITEM Club expects the Chancellor to use the Budget to start to wind down the various COVID-19 support schemes – but only after extending some of them to ensure they last until recovery is underway.

The EY ITEM Club says the Chancellor is likely to extend the furlough scheme while announcing a plan to phase it out. Extended grants and targeted support are likely for sectors facing a longer recovery, such as airlines or hospitality businesses, which could see bespoke furlough schemes. At the same time, some measures due to end on 31 March – including the business rates holiday and temporary sector-specific VAT cut – may be extended.

A short extension of the temporary increase in the Stamp Duty threshold beyond 31 March is also a possibility.

The EY ITEM Club believes the Chancellor will look at extending or making permanent the temporary £20 increase weekly increase in Universal Credit payments, which is due to end in April. The Chancellor may also provide support to the labour market with advice and skills schemes to help workers move out of sectors where demand has been permanently affected by the pandemic. These schemes would build on those launched last year to boost job searches and expand training.

A return of the Eat Out to Help Out scheme and other measures to boost spending in pandemic-affected sectors is also not ruled out by the EY ITEM Club.

And, with February’s EY ITEM Club Financial Services Forecast reporting that UK firms responded to the pandemic by borrowing a net £35.5bn last year – with a further £26bn of borrowing expected in 2021 – there is scope for the Chancellor to take steps to reduce the challenges debt-heavy balance sheets might pose to business investment.

Martin Beck says: “Several of the measures announced last summer and autumn were a dry run for the steps the Chancellor is likely to take now: phasing out support and encouraging to consumers to spend. The COVID-19 vaccines should help ensure the Chancellor doesn’t have to reverse course later, however, and Wednesday should see the last significant COVID-19 support measures announced.

“If there are steps towards fiscal consolidation, they are likely to be relatively small and may include a corporation tax rise.”

Levelling up and public investment likely to be third element of Chancellor’s plans

The EY ITEM Club says that the Budget could also include steps to promote long-term growth and a levelling-up of the economy through public investment in infrastructure and Research & Development (R&D).

Hywel Ball, EY’s UK Chair, says: “As well as ongoing and transitional support, businesses will also be looking to the Chancellor to set out a longer-term plan for the UK economy as they prepare their own post-COVID and post-Brexit investment plans. 

“Initiatives to support a green recovery, steps to deliver levelling-up and inclusive growth, and a vision for how the UK economy can remain internationally competitive are vitally important.

“Infrastructure and R&D spending could also help both the supply and demand sides of the economy. In terms of impact, public investment is one of the strongest tools available to the Government. Research shows that a £1bn rise in public investment can deliver an increase in GDP three times higher than the boost to output from a £1bn income tax or VAT cut.”