Q. That was good news, wasn’t it?
A. On the face of it, yes. George Osborne was able to stand at the Dispatch Box of the House of Commons and announce the biggest upward revisions to a set of official growth forecasts since 1999. At the time of the March Budget, Robert Chote’s Office for Budget Responsibility (OBR) was expecting growth this year of 0.6 per cent. Yesterday it more than doubled that figure to 1.4 per cent. In March the OBR expected 1.8 per cent growth in 2014. Now it sees growth coming in at 2.4 per cent in that year. On the OBR’s forecasts Britain will be back to its 2008 levels of economic output next year.
Q. So does that mean the deficit is falling faster too?
A. Yes – it will descend quicker than forecast in March. The OBR estimates that the Treasury will borrow £111bn in 2013-14, some £9bn less than it estimated at the time of the last Budget. Borrowing will be lower in every subsequent year too, as the first chart shows, resulting in a cumulative state borrowing bill £70bn lower than anticipated in March. There will even be a slim budget surplus of £2.2bn in 2018-19, which will be the first time the Government’s annual books have been balanced since 2001-02.
Mr Osborne will comfortably meet the first part of his fiscal mandate to eliminate the structural deficit on day-to-day spending over five years. He’s still set to miss the second part, namely ensuring that the public sector net debt peaks as a share of GDP by the end of the Parliament. But the national debt will still peak a year earlier (2015-16) on this measure than the OBR expected in March.
Q. Isn’t there space for the Chancellor to ease off on austerity now?
A. The short answer is no. And the reason is that, despite the rosier near-term headline GDP forecasts, the OBR has not revised up its estimate of the growth potential of our economy. Thus it thinks the economy’s so-called “output gap” is smaller than it believed in March. This means that over the next few years the structural deficit on current spending (the part of public borrowing that will not naturally be eroded as output snaps back to potential) will actually be larger than it expected back in March.
One can see this in the second chart. In this respect the hole in the public finances can be said to have got worse, not better. The upshot is that there is not actually much spare room, in the OBR’s eyes, for Mr Osborne to ease up on his schedule of cuts – at least not if the Chancellor wants to stick to his self-imposed fiscal mandate.
Q. But will the recovery even be sustained?
A. Many are doubtful. The recovery we have experienced this year – which took the OBR and most other forecasters by surprise – has been driven by a surge in household spending and underpinned by the reviving housing market. The growth forecast upgrade this year is due to primarily to consumer investment.
The OBR also noted yesterday that this household consumption has been financed by reductions in saving, rather than higher wages or incomes. The breakdown of the OBR’s growth forecasts by expenditure component (see chart 3) suggests that this reliance on consumption is set to continue into 2018. Household spending contributes half of all growth. Strikingly, net trade (imports minus exports) is set to deliver no boost to GDP whatsoever.
It is also striking to compare this with the OBR’s forecasts at the time of the 2010 election, when it saw net trade providing a fifth of all the growth in 2014 and 2015. Most of the heavy work was supposed to be done by trade and business investment. But that “rebalancing” has pretty much gone by the board.
Another way of looking at this is to examine the OBR’s forecasts for the so-called “sectoral balances”. As a matter of arithmetic, government borrowing in any given year (the deficit) always has to be offset by an equal amount of business and household saving or foreign lending. So for government borrowing to fall, as the deficit is closed, business and household saving has to fall, too. Under the OBR’s forecasts, business saving does come down over the next five years, but it remains in the black. Most of the rebalancing is achieved by households taking on more credit.
Q. Does that mean households will go back into debt?
A. In one important measure, yes. The OBR’s figures show that the UK’s aggregate debt-to-income ratio, which has been falling in recent years as people have sought to improve their finances, is set to rise.
The fourth chart shows that the ratio will go up from around 140 per cent of incomes to 160 per cent by 2018, a steeper rise than was expected nine months ago. This is largely because the OBR thinks more people will take out mortgages in the coming years in order to buy expensive houses. It says that house prices will be some 10 per cent higher by 2017-18 than it expected in March, something the watchdog attributes to Mr Osborne’s mortgage subsidies. Help to Buy will also help to push Britons into debt.
Q. That doesn’t sound like such good news after all…
A. Things just about hold together under the OBR’s forecasts. Despite its pessimism over the economy’s growth potential (which one would normally associate with the threat of inflation) the OBR sees prices remaining under control over the forecast period. Consumer prices inflation is set to descend gently to the Bank of England’s 2 per cent target in the coming years and then to stay there. The unemployment rate is seen as coming down more rapidly than in March. But it does not fall so fast to the Bank of England’s 7 per cent forward guidance threshold that it risks triggering a potentially destabilising interest rate hike from the Bank. This is reflected in the OBR’s benign forecast for interest rates. If this is right, households should be able to service their new debts and continue to support the economy through spending. But it will be a stretch.
And the OBR has been very wrong before. In June 2010 it forecast the economy would have grown by 9 per cent by the middle of this year. In fact the expansion was a third of that. For the sake of this fragile recovery, we need to hope that the OBR has managed to do a better job this time.