Q.What happened to the forecasted growth?
A. The Office for Budget Responsibility, the Government's official fiscal watchdog, says that the life has been effectively squeezed out of the UK economy over the past year by higher than expected inflation. When it presented its analysis of the national finances at the time of the last Budget in March, the OBR said that growth was likely to be 1.7 per cent over 2011. But yesterday the OBR was forced to slash that estimate to just 0.9 per cent. And things are not expected to get any better next year.
In March, the OBR expected growth in 2012 to be a robust 2.5 per cent. But yesterday it said that growth over the next 12 months will be just 0.7 per cent, which means the economy will be essentially stagnant for the first half of the year. In his Budget speech in March, George Osborne was optimistic about the UK's growth prospects. He said that the "private sector growth must take the place of government deficits".
Mr Osborne and the Treasury expected a boom in British exports. Manufacturing was also expected to undergo a national resurgence. The Chancellor spoke of Britain being "carried aloft by the march of the makers". But none of that has happened. Or at least, it has not happened as fast as the Chancellor and the OBR expected six months ago. UK growth does, however, pick up under the OBR's projections in 2013 and 2014, although still at a lower rate than forecast in March.
Q. What does this mean for public borrowing?
A. Lower growth means higher than expected unemployment levels as fewer of the public sector workers being laid off in the coming years are absorbed into the private sector. The OBR expects unemployment to rise to 8.7 per cent of the labour force in 2013, up from 8.1 per cent expected in March. This translates into higher than expected welfare payments. The OBR says that 1.67 million Britons will be on the dole by 2014. In March it said the claimant count would peak at 1.54 million this year and fall steadily over the coming years.
Weak economic activity also means lower than expected tax revenues for the Treasury. All this means that the deficit – the amount that the Government must borrow each year to meet its outgoings – will not now fall on the timetable laid out by the Chancellor. The OBR said that public borrowing will come in higher every year of this parliament than it expected in March. By 2015-16 the OBR expects the Government to be borrowing £53bn (2.9 per cent of GDP), up from £29bn (1.5 per cent of GDP) forecast in March. This means that total cumulative borrowing over the next five years will be £111bn more than anticipated in the spring. The annual deficit gets added to the national debt each year, so the latter will rise too due to lower growth.
Annual public sector net debt is now forecast by the OBR to peak at 78 per cent of GDP in 2014-15, up from 71 per cent forecast in March.
The one bit of mitigating good news is that the UK's borrowing costs have fallen as investors have rushed to buy British government bonds, which they regard as a safe asset, in recent months. The OBR estimates that these lower interest rates will save the Government around £22bn in interest payments over the next four years.
Q. Does this mean the Chancellor will miss his fiscal targets?
A. In his March Budget speech George Osborne said that he would achieve a balanced current budget "by the end of the parliament". Given that the next election is scheduled to take place in the spring of 2015 and the OBR confirmed yesterday that the national books will not now be balanced until 2016-17, Mr Osborne will clearly not hit that target. Yet the "fiscal mandate" that Mr Osborne announced in June 2010 actually contained some flexibility. It committed the Government to bring spending into balance with revenues over a rolling five-year time horizon.
So long as Mr Osborne is on target to balance the budget over the next half decade, he is fulfilling his mandate. Yet the OBR has also revised its view of the underlying productive potential of the UK economy. It now says that there is less "spare capacity" in the economy than it previously believed. This means that more of the public sector deficit is "structural" rather "cyclical", meaning it will not automatically disappear when growth returns. And this judgement, in turn, required Mr Osborne to cut or tax more in order to bring the budget into balance over the five-year timeframe. Mr Osborne did so yesterday, with his plans to hold down public sector pay for longer and to cut child tax credits. The OBR said that these measures will reduce government borrowing by £8.3bn in 2015-16 and £15.1bn in 2016-17 keeping the Government on course to hit its targets.
The second part of the Chancellor's fiscal mandate was for the national debt, measured as a share of GDP, to be falling by end of the parliament. The OBR says he will achieve this. Though national debt will rise to 78 per cent of GDP in 2014-15, the OBR says it will fall to 77.7 per cent in 2015-16. That is hardly a significant fall, but it is technically enough to meet the target.
Q. So will austerity now last longer?
A. Yes. George Osborne originally intended to balance the budget by 2014-15, which would have given him room to announce tax cuts before the next election. But as he admitted yesterday, the "headroom" for such largesse has now gone. The Conservatives will go into the next election still committed to a programme of spending cuts and tax rises. Low growth also means that living standards will be squeezed for longer. In March the OBR expected real wage growth to turn positive next year. That turning point has now been pushed back to 2013.
Q. But is there light at the end of the tunnel?
A. The OBR says that Britain should avoid a recession next year. But other forecasters, including the Organisation for Economic Co-Operation and Development, expect an economic contraction. There is also the threat to the UK economy posed by the chaos in Europe, our largest single export market. The OBR says its weak outlook is based on the assumption that the single currency area "finds a way through its current crisis and that policymakers eventually find a solution that delivers sovereign debt sustainability". That is looking like an increasingly questionable assumption. The OBR has downgraded its growth forecasts four times since Mr Osborne's first emergency Budget in June 2010. It might well have to do so again.