Tomorrow, Philip Hammond, will present not only his first fiscal statement to Parliament, but the Office for Budget Responsibility’s first post-referendum forecast.
Rather than just second guess how the OBR’s forecasts might change, what follows dissects how our Nation Institute of Economic and Social Research (NIESR) forecasts for the public finances have evolved between May and November of this year.
That we have revised up our forecasts for government borrowing might not come as a surprise, but what might surprise is that we have revised up by only a cumulative £50bn (or £10bn per annum).
So what's going on?
Offsets play a significant role.
There is the direct effect on the public finances from recent monetary policy decisions, but there is also a large unknown in the form of future contributions to the EU’s budget.
Changes to the economic outlook are behind higher borrowing forecasts
We have lowered our economic growth forecasts over for the next few years, with the slowdown concentrated in 2017.
This temporary slowing is largely due to a drop in domestic demand; elevated uncertainty weighs on investment decisions, while the purchasing power of many households will be eroded by the pass through into consumer prices from the recent depreciation of sterling.
Weaker growth maps into weaker tax revenues and higher spending on out of work benefits.
In May we expected cumulative public sector net borrowing of £137bn over the period 2016/17 to 2020/21.
Our more recent subdued economic projections increase our borrowing projections over this same period by around an additional £81bn.
This is, however, only part of the story.
Our forecasts for borrowing have actually been revised up by only £50bn.
So why do we increase our borrowing projections by £50bn instead of £81bn?
This comes from two important offsetting factors: monetary policy and EU budget contributions.
Looser monetary policy is a direct offset
That monetary policy always has implications for the public finances is well known.
After all, changes in interest rates affect the borrowing costs of the government, just as they do households and firms.
The loosening of monetary policy announced in August directly improves the public finances substantially.
The Bank of England is on course to hold £435bn of government bonds.
At the same time, the Bank receives coupon payments on its stock of gilt holdings.
Since 2012 it has returned this cash to the Exchequer, less a fee charged at Bank Rate.
The reduction in Bank Rate in August means more cash now flows back to the government.
Finally, the additional purchase of bonds by the Bank pushes up the price of government bonds.
With prices further above par, fewer bonds need issuing to meet the government’s cash requirement.
Our estimates suggest the direct effect of recent monetary policy changes will improve the public finances by a cumulative £15bn.
Future contributions to the EU Budget key, but highly uncertain
Upon exit in 2019 we have assumed that the UK will no longer contribute to the EU budget, improving the position of the public finances by almost £8bn per annum in each of 2019/20 and 2020/21.
This is an admittedly heroic assumption.
The new relationship with the EU may involve a contribution to the EU budget.
Indeed, this is the case for EEA members and Switzerland.
This could be one of the key surprises in the OBR’s forecast.
Their remit is to produce a forecast based on government policy, but given that we do not yet know what Brexit actually means how they will approach assumptions about future EU budget contributions is a large unknown.
The size of borrowing still expected to shrink each year
What does this mean for trajectory of borrowing?
Despite the multiples of billions in additional borrowing just discussed, it does not change the overall profile too much.
Borrowing, both as a percentage of GDP and in money terms, is still expected to shrink, just at a slower pace.
What experts have said about Brexit
What experts have said about Brexit
1/11 Chancellor of the Exchequer Philip Hammond
The Chancellor claims London can still be a world financial hub despite Brexit “One of Britain’s great strengths is the ability to offer and aggregate all of the services the global financial services industry needs” “This has not changed as a result of the EU referendum and I will do everything I can to ensure the City of London retains its position as the world’s leading international financial centre.”
2/11 Yanis Varoufakis
Greece's former finance minister compared the UK relations with the EU bloc with a well-known song by the Eagles: “You can check out any time you like, as the Hotel California song says, but you can't really leave. The proof is Theresa May has not even dared to trigger Article 50. It's like Harrison Ford going into Indiana Jones' castle and the path behind him fragmenting. You can get in, but getting out is not at all clear”
3/11 Michael O’Leary
Ryanair boss says UK will be ‘screwed’ by EU in Brexit trade deals: “I have no faith in the politicians in London going on about how ‘the world will want to trade with us’. The world will want to screw you – that's what happens in trade talks,” he said. “They have no interest in giving the UK a deal on trade”
4/11 Tim Martin
JD Wetherspoon's chairman has said claims that the UK would see serious economic consequences from a Brexit vote were "lurid" and wrong: “We were told it would be Armageddon from the OECD, from the IMF, David Cameron, the chancellor and President Obama who were predicting locusts in the fields and tidal waves in the North Sea"
5/11 Mark Carney
Governor of Bank of England is 'serene' about Bank of England's Brexit stance: “I am absolutely serene about the … judgments made both by the MPC and the FPC”
6/11 Christine Lagarde
IMF chief urges quick Brexit to reduce economic uncertainty: “We want to see clarity sooner rather than later because we think that a lack of clarity feeds uncertainty, which itself undermines investment appetites and decision making”
7/11 Inga Beale
Lloyd’s chief executive says Brexit is a major issue: "Clearly the UK's referendum on its EU membership is a major issue for us to deal with and we are now focusing our attention on having in place the plans that will ensure Lloyd's continues trading across Europe”
8/11 Colm Kelleher
President of US bank Morgan Stanley says City of London ‘will suffer’ as result of the EU referendum: “I do believe, and I said prior to the referendum, that the City of London will suffer as result of Brexit. The issue is how much”
9/11 Richard Branson
Virgin founder believes we've lost a THIRD of our value because of Brexit and cancelled a deal worth 3,000 jobs: We're not any worse than anybody else, but I suspect we've lost a third of our value which is dreadful for people in the workplace.' He continued: "We were about to do a very big deal, we cancelled that deal, that would have involved 3,000 jobs, and that’s happening all over the country"
10/11 Barack Obama
US President believes Britain was wrong to vote to leave the EU: "It is absolutely true that I believed pre-Brexit vote and continue to believe post-Brexit vote that the world benefited enormously from the United Kingdom's participation in the EU. We are fully supportive of a process that is as little disruptive as possible so that people around the world can continue to benefit from economic growth"
11/11 Kristin Forbes
American economist and an external member of the Monetary Policy Committee of the Bank of England argues that the economy had been “less stormy than many expected” following the shock referendum result: “For now…the economy is experiencing some chop, but no tsunami. The adverse winds could quickly pick up – and merit a stronger policy response. But recently they have shifted to a more favourable direction”
The key to this continued reduction in borrowing is one crucial fact that has not changed: there is still a significant amount of fiscal consolidation planned for this Parliamentary term.
At around 6 per cent of GDP (£120bn in 2016 money), the consolidation planned for this Parliament, is of a similar magnitude to that undertaken by the coalition government over their term in office.
Finally, what might this all mean for the OBR’s borrowing projections?
And finally how do these figures compare to OBR’s March forecast?
NIESR’s pre-referendum projection for the public finances was more conservative than the OBR’s - meaning we already expected the Government to borrow more.
The difference between our current borrowing forecasts and those of the OBR's from March is now £92bn (including the monetary policy and EU budget assumptions).
Whether the change in the OBR’s forecast hits £100bn or not will depend on assumptions they make about EU contributions and how generous the Chancellor chooses to be this side of Christmas.
Simon Kirby is Head of Macroeconomic Modelling and Forecasting at the National Institute of Economic and Social Research.