The Office for Budget Responsibility (OBR) forecasts (which underpin the Budget) see less economic ‘scarring’ from the pandemic than previously expected. Economic forecasts have generally been revised up. That comes alongside actual fiscal policy outturns coming in better than expected this year so far.
All that has resulted in an effective fiscal ‘windfall’ which has been partly spent and partly ‘banked’ by the Chancellor, leaving the fiscal projections looking healthier than they were in March. However, the forecasts look vulnerable to higher inflation and interest rates and were finalised before some of the recent increases in market-implied interest rates or energy prices for example could be taken into account.
Going into the Budget, UK fiscal finances were already looking much better than expected. The OBR’s pre-measures projection for the main measure of the deficit (that is after changes in the economic backdrop are taken into account, but before including policy changes) was some £38bn lower a year on average than in the March forecasts. The OBR are clear that inclusion of more recent increases in energy prices and market interest rates would have had an unfavourable impact on the public finances though.
Net fiscal stimulus versus March: The policy changes included in this Budget are fiscally stimulative overall. Compared to March, this Budget sees tax policy decisions worth nearly £13bn in extra revenue by 2026-27, but public spending decisions worth an extra £23bn a year by the same point. For the coming fiscal year, the decisions look even more net stimulative than this compared to the March figures (by about a net £25bn, or more than 1% of GDP).
However, these fiscal policy changes may not feel very stimulative to many households, where they now also incorporate previously announced tax increases (the health and social care levy) and once a higher cost of living is taken into account (the OBR’s inflation forecasts are now dramatically higher over the next couple of years than they previously were). On addressing the cost of living – there were some welcome Universal Credit changes, but these occur against the backdrop of the pandemic-uplift having already been cut. There were also cuts to and freezing of several duty rates.
The most costly, or revenue raising, decisions taken by the Chancellor and incorporated in this Budget included:
- Increases in planned public departmental spending, including the extra for health and social care (and the offsetting NICs-like Health and Social Care levy)
- Reducing the Universal Credit taper rate
- The temporary extension of business rate relief for retail, hospitality and leisure and freezing the business rates multiplier
- On the ‘spending less’ side, changes to the pensions triple lock
But overall fiscal policy is still set to become less supportive: The overall path for fiscal policy still points to a significant tightening in fiscal stance compared to 2020. The cyclically-adjusted primary deficit – changes in which are a crude proxy for how much net fiscal tightening or loosening is planned – goes from 14.2% of GDP in 2020-21 to 6.7% in 2021-22, then 2.5% in 2022-23 and 1.6% GDP by 2023-24. As this measure falls it signals a tightening in the fiscal stance, though a large chunk of the tightening in the current fiscal year will presumably reflect the end of the furlough scheme. Alongside a bit of a cost-of living shock for households and likely tighter monetary policy, a less supportive fiscal stance remains one of the factors likely to drag somewhat on the UK’s economic recovery next year.
What does extra net stimulus mean for the Bank of England (BoE)? Given that the overall policy measures are fiscally stimulative compared to the March Budget, this Budget – in isolation – arguably increases the chance of a rate rise next week from the BoE. I am still assuming that they hike in February rather than November (or even December), see ‘Could we really get a Bank of England rate rise in November?’, but that feels like a close call given the lack of pushback to market expectations from most Monetary Policy Committee members.
Healthier fiscal numbers, less issuance: After including all of the policy changes, the deficit forecast for the current year fell £51bn to 7.9% GDP. That points to lower issuance too: Gilt issuance for the current fiscal year has been cut by £57.8bn.
By 2026-27, the main measure of the deficit is 1.5% GDP, with borrowing lower in every year compared to the March forecasts, reflecting the improvement in the pre-measures fiscal outlook only partly being offset by new fiscal measures. Debt to GDP is set to fall as a percentage of GDP by only 2024-25 though, and is still at a high level by UK standards. The better starting point will help, but it is unlikely that much in this Budget will stop UK fiscal finances being on a long-term very challenging path, driven by demographics and an aging population.
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