Martin Beck, senior economic advisor to the EY ITEM Club, comments:
“As expected, the OBR delivered a substantial reduction in its forecast for government borrowing this year and beyond, aided by upgrades to GDP growth and a cut in its estimate of the pandemic’s long-run ‘scarring’ effect on the economy. Public sector net borrowing is now expected to be 7.9% of GDP in 2021-22 compared to 10.3% of GDP in March, falling to 3.3% of GDP in 2022-23 from 4.5% of GDP and stabilising at around 1.5% of GDP in 2025-26 (2.8% of GDP previously). And public sector debt is forecast to not exceed 90% of GDP over the next five years, 10ppts of GDP lower than March’s forecast.
“In some respects, the OBR’s latest forecasts probably paint an overly rosy picture of the public finances – the 24 September cut-off date for the forecast means it didn’t capture the big rise in gilt yields and expectations for Bank Rate and RPI inflation which occurred earlier this month. These factors point to debt interest payments being around £10bn higher in 2022-23 than forecast. However, the forecast closing unusually early also meant upward revisions to GDP released by the ONS at the end of September were also missed out. These omissions probably roughly cancel out.
“In broad terms, the Chancellor intends to continue with withdrawing pandemic-related fiscal support and raising taxes at the same time as households face escalating cost of living pressures over the winter and into 2022. But the Budget went some way to alleviating those pressures. The rate at which Universal Credit is tapered will be cut from 63p in every pound earned to 55p, more than was speculated. This will cost the exchequer around £3bn by the middle of the decade and allow claimants to keep more of their wages, although the new policy won’t help out-of-work households. The freeze on public sector pay will also end. However, surprisingly, there was no action to offset soaring energy costs, such as a cut in VAT on fuel bills.
“Today’s biggest ‘giveaways’ were in the Spending Review, which was published alongside the Budget. A planned £150bn cash increase for public services over the current parliament means a bigger envelope for total public spending than was set out by the Chancellor in September. Spending will rise by 3.8% in real terms each year, a significant break with the much more sluggish growth, or even real-terms fall, seen in the austerity decade of the 2010s.
“Meanwhile, we saw a return to fiscal rules, which were suspended during the pandemic. The intention is to have public debt falling and, in normal times, borrowing only for investment, with everyday spending covered by taxation. The new rules, which will be enshrined in a fiscal charter, must be hit by third year of every forecast period.
“The OBR’s decision to cut its ‘scarring’ estimate down to 2% from 3% previously still looks unduly pessimistic, given the worst of the pandemic has now passed. The Bank of England’s most recent estimate is 1% and there’s a reasonable argument that developments during lockdowns such as increased digitisation and a move to more efficient working practices may even have boosted the economy’s capacity. So there's a good chance the OBR will again cut its view of scarring further down the track.
“Despite today’s ‘giveaway’, the Chancellor has been cautious. Borrowing falls below 2% of GDP from 2023-24 onwards, meaning a current budget surplus of £ £25bn or just under 1% of GDP in 2024-25. So the most prominent of the Chancellor’s new fiscal targets will be met with ample headroom. Combined with any further cuts in the OBR’s scarring estimate, the Chancellor may well end up with a big pre-election war chest to spend on tax cuts or spending increases.
“But after the biggest recession in living memory, a record rebound in employment, unprecedented government spending and volatile inflation – all against the backdrop of a global pandemic – predicting where the public finances are headed is even harder than normal. This is amply demonstrated by the scale of revisions in today’s new OBR forecasts. If the Chancellor wants to dispense the largesse promised today, and potentially more in the future, while meeting his new fiscal rules, he’ll be hoping that those OBR predictions prove accurate.”