Despite a brighter near-term economic picture than had been expected at last November's Autumn Statement, the Chancellor remains cautious about the longer-term outlook. Consequently, the overall fiscal stance is essentially unchanged in the March 2017 budget.
Implications | Despite the resilience of the UK economy through the second half of 2016, Chancellor Philip Hammond still sees the outlook as challenging and uncertain as the government looks to negotiate the country's exit from the European Union. He also remains committed to getting the public finances into sustainable shape, albeit over an extended period. Consequently, the Chancellor announced an essentially fiscally neutral budget. |
Outlook | All the economic forecasts contained in the budget have to be considered in the context of massive uncertainty over how the United Kingdom's relationship with the European Union will develop over the next few years and what arrangements will eventually be reached regarding trade, access to EU markets, and immigration. |
A cautious, steady overall approach is essentially the defining feature of the budget.
Chancellor Philip Hammond is clearly keen to keep fiscal ammunition up his sleeve – due to the major uncertainties and downside risks that the UK economy faces as it navigates its way out of the European Union. Despite the resilience of the economy so far since last June's Brexit vote, the Chancellor is very well aware that a challenging road lies ahead. Furthermore, an appreciable budget deficit is still seen existing in 2021/22 so there is still work to be done then on getting the public finances back to full health. The Chancellor stated that the only responsible plan is to continue to work to bring the budget deficit down.
There are limited targeted measures, most notably aimed at providing relief for small businesses suffering the most from changes in business rates and extra funds for social care for the elderly. As part of the government's stated priority of lifting productivity, there are a number of measures aimed at supporting education, developing technical skills, and fostering research and development.
To help fund these measures, there is an increase in national insurance contributions from the self-employed. There is also a reduction in the tax-free dividend allowance (from GBP5,000 to GBP2,000) that company directors and private shareholders can receive.
Little change to fiscal stance
As expected, the Chancellor essentially stuck to the fiscal course that he had set out in last November's Autumn Statement. The Office for Budget Responsibility (OBR) concluded that the budget is slightly stimulative for 2017/18 (between GBP1.7 billion and GBP3.1 billion depending on the basis calculated). There is a modest net takeaway from 2019/20 or 2020/21, again depending on the basis calculated.
The OBR concluded that the Chancellor is on target to meet his target for structural borrowing in 2020–21 with room to spare, but not yet to achieve his goal of balancing the public finances "at the earliest possible date in the next parliament". Specifically, the fiscal rules adopted by Hammond in last November's Autumn Statement included (1) the public finances should balance as early as possible in the next parliament (due in May 2021) and there must be a cyclically adjusted budget deficit (i.e. structural deficit) below 2% of GDP in 2020/21 and (2) net debt must fall relative to GDP in 2020/21.
The OBR's latest forecasts see a structural budget deficit of 0.9% of GDP in 2020/21, with net debt starting to fall relative to GDP in 2018/19.
The Chancellor has a rainy day fund in case there are severe economic storms ahead as Brexit proceeds. The OBR calculates that the Chancellor has GBP25.8 billion spare to meet the structural budget deficit target in 2020/21. The Chancellor can also run a bigger deficit if the economy suffers a larger cyclical downturn than expected.
It is notable that while the GDP growth forecast for 2017 has been revised up markedly (from 1.4% to 2.0%) and the expected budget deficit for 2016/17 has been cut by GBP16.4 billion (to GBP51.7 billion from GP69.2 billion), the longer-term picture of the economy is essentially unchanged from last November's Autumn Statement. This is because the OBR has trimmed the GDP growth projections for 2018–20. Consequently, the economy in 2020 is still seen as having the same size as expected in November while an anticipated budget deficit of GBP16.8 billion in 2021/22 is little changed from the previously expected GBP17.2 billion shortfall.
Outlook and implications
All the economic forecasts contained in the budget have to be considered in the context of massive uncertainty over how the United Kingdom's relationship with the European Union will develop over the next few years and what arrangements will eventually be reached regarding trade, access to EU markets, and immigration. The growth forecasts for 2019 and beyond are particularly uncertain given that the United Kingdom is due to leave the European Union in April 2019 (assuming Article 50 is triggered by the end of March) and nobody knows what arrangements will be in place by then.
Growth
Reflecting the economy's extended resilience since last June's Brexit vote, the OBR sharply raised projected UK GDP growth in 2017 to 2.0% from the 1.4% expected in last November's Autumn Statement.
Significantly, though, this improvement is not seen lasting as growth projections have been trimmed for 2018 (to 1.6% from 1.7%), 2019 (to 1.7% from 2.1%), and 2020 (to 1.9% from 2.1%). Growth in 2021 is still seen at 2.0%.
While the economy ended 2016 better than expected, we believe the upgrading of the 2017 GDP growth forecast to 2.0% may be over-optimistic and we also suspect that growth will come in lower than the OBR expects in 2018. In particular, there are mounting signs that consumers are now starting to rein in their spending as their purchasing power is increasingly squeezed by rising inflation. Furthermore, we suspect that inflation will rise more than the OBR forecasts (which see it averaging 2.4% in 2017 and 2.3% in 2018) so the squeeze on consumers will be deeper than it expects.
Consequently, we expect GDP growth to come in around 1.6% in 2017 and we see it slowing to 1.2% in 2018. We see growth picking up to a limited extent in 2019 (to 1.5%) and 2020 (1.8%).
Fiscal forecasts
The OBR now sees Public Sector Net Borrowing excluding banks (PSNBex) being GBP23.8 billion lower during 2016/17 to 2021/22 than it had expected at November's Autumn Statement. However, this improvement is largely concentrated in 2016/17 (to the tune of GBP16.4 billion) due to one-off and timing factors, rather than perceived structural changes. In fact the 2017/18 deficit is seen rising from the expected 2016/17 shortfall and an appreciable shortfall is still seen in 2021/22.
Specifically, PSNBex is now seen coming in at GBP51.7 billion (2.6% of GDP) in 2016/17 then rising to GBP58.3 billion (2.9% of GDP) in 2017/18 before coming down progressively to GBP40.8 billion (1.9% of GDP) in 2018/19, GBP21.4 billion (1.0% of GDP) in 2019/20, GBP20.6 billion (0.9% of GDP) in 2020/21, and GBP16.8 billion (0.7% of GDP) in 2021/22
In November, PSNBex had been seen at GBP68.2 billion (3.6% of GDP) in 2016/17, coming down to GBP59.0 billion (2.9% of GDP) in 2017/18, GBP46.5 billion (2.2% of GDP) in 2018/19, GBP21.9 billion (1.0% of GDP) in 2019/20, GBP20.7 billion (0.9% of GDP) in 2020/21, and GBP17.2 billion (0.7% of GDP) in 2021/22.
If GDP growth comes in less than the OBR forecasts as we expect, then the Chancellor will be highly likely to miss these fiscal targets. However, he has scope to do so under the fiscal mandate he adopted in the Autumn Statement.