David Page, UK Budget reaction

David Page, UK Budget reaction

Market commentary News
23 November 2017

David Page, Senior Economist at AXA IM provides an overview of today’s UK Budget

“The key question is whether this will provide a boost to the economy. To our minds, targeted infrastructure spending is welcome against a background of weak productivity growth. We can also see multiplier benefits from rejuvenating UK housebuilding in an effort to achieve a 300k per annum house build by mid-2020s. However, some of today’s measures struck as purely populist, including the £5.4bn in waived revenue as duties on fuel and alcohol were frozen. Importantly, the Chancellor’s spending effort has not obviously improved the OBR’s assessment of the future (although today’s drop in productivity, potential GDP and actual GDP forecasts would have surely have been deeper without this spending boost).”             


See full summary below:

“The Chancellor’s first Autumn Budget today exceeded our expectations for spending. Chancellor Hammond cast off his reputation for caution announcing a net £25bn give-away in today’s Budget, with measures focused on productivity improvement as well as more politically sensitive areas such as housing, the NHS and cost-of-living issues. Some of this spending was financed by the outlook for a smaller-than-expected deficit this year. More came from a technical reclassification of debt, which helped lower debt interest payments, and anti-tax-avoidance measures hoped to raise nearly £10bn over the coming years. However, a large portion of this spending will be shouldered by increased borrowing, with the projected deficit rising by £30bn over the forecast horizon, despite starting the period £10bn to the better. The Chancellor discussed the fact that debt was set to fall as a percentage of GDP as a ‘turning point’ for the UK economy; the significantly reduced outlook for fiscal rectitude certainly heralds a new era for the UK public finances.     


“As expected the Chancellor was dealt a blow by the Office for Budget Responsibility (OBR) that revised down both its estimates of GDP and potential GDP growth. The latter was an exercise in outcome over forecast. Having forecast a resumption of solid productivity growth since inception, the OBR threw in the towel, today reducing its productivity growth forecast by around 0.5% per annum over the forecast horizon. With  other technical adjustments, this was reflected in a weaker potential growth outlook of the same magnitude. Accordingly, the OBR lowered its GDP outlook sharply. GDP is now forecast at 1.5% for 2017 (from 2.0% in March), 1.4% in 2018 (1.6%) and 1.3% in 2019 (1.7%), with growth thereafter assumed to rise gradually to 1.6% by 2022. The OBR’s forecasts are now in line with our own outlook at 1.5%, 1.4% and 1.4% for 2017, 2018 and 2019 respectively.


“Nevertheless the Chancellor unleashed a significant boost to the public spending profile. His choice of spending targets resonated politically. Beyond a £9bn addition to the National Productivity Fund (with obvious need), other spending included £9bn to improve house building and homeownership, with a headline-grabbing cut in Stamp Duty for first time buyers; £7bn to the NHS; £5.4bn to households via waived duty increases on auto fuel and alcohol duties; and £2.3bn to businesses via a technical change in inflation index being introduced earlier. Little of this was offset by increased taxation (although total tax and avoidance measures are hoped to raise around £9bn over the forecast horizon).


“The Chancellor’s largesse was financed from a variety of sources. The public finances have performed better across the course of this year than forecast (some £8bn lower than the OBR forecast in March). The Chancellor also benefitted from a reclassification of Housing Association debt, which contributed to a lowering of debt interest overall. However, much of this spending has been afforded by increased borrowing. Despite an expected better-than-forecast deficit this year, borrowing over the next five years is forecast £29bn higher than in March. The increase in borrowing from 2019-20 to 2021-22 is £39bn.


“Admittedly the Chancellor has remained within his fiscal rules, although we note that the ‘headroom’ that the Chancellor referred to as a prudent measure just one year ago has been reduced by around £10bn after today’s spending surge. Moreover, the overall debt level is forecast to have peaked at 86.5% this year, 2.3% points lower than forecast in March. However, this improvement reflects more than anything the technical change in Housing Association debt. The 2.3% improvement in debt is reduced to just a 0.5% improvement in expected debt levels in 2021-22 as higher borrowing and weaker GDP growth quickly erode this one-off improvement. Indeed, the fiscal stance has eased materially. The tightening fiscal position that was envisaged in March of around 1% point per annum in 2018-19 and 2019-20 has now been reduced to a fiscal tightening of 0.5% and 0.3% points respectively. It is modest thereafter as borrowing is left consistently higher at the end of the forecast horizon.


“Going into this Budget, political pressure had grown for the Chancellor to try to revive flagging Tory fortunes with well-targeted spending. Chancellor Hammond has responded. While it may take some time to shift youth perceptions of current Conservative government policy, the Chancellor’s spending targets allowed him to discuss a future based around tech-driven growth and where younger households would be able to increasingly be homeowners again. This is certainly something that should get backbench Tories onside and avoid the embarrassments of the last Budget.


“The key question is whether this will provide a boost to the economy. To our minds, targeted infrastructure spending is welcome against a background of weak productivity growth. We can also see multiplier benefits from rejuvenating UK housebuilding in an effort to achieve a 300k per annum house build by mid-2020s. However, some of today’s measures struck as purely populist, including the £5.4bn in waived revenue as duties on fuel and alcohol were frozen. Importantly, the Chancellor’s spending effort has not obviously improved the OBR’s assessment of the future (although today’s drop in productivity, potential GDP and actual GDP forecasts would have surely have been deeper without this spending boost).             


“Financial market reaction to the Budget has been so far been muted. Movements in 2-year and 10-year yields (down around 2bps to % and 1.27%) broadly reflected international trends, with little change in gilt-US Treasury spreads. Similarly while sterling rose by 0.4% to the US dollar, this appeared to simply keep pace with the fall in US dollar to the euro – indeed sterling:euro was stable over the period. The FTSE 100 also fell back by 0.4%, however, again this was likely more reflective of movements in the currency. For now the Chancellor has managed to pull off a significant increase in spending without breaching his fiscal rules. Financial markets appear to have reserved judgement for now. The Chancellor will hope this remains the case.” 



Appendix – A more detailed assessment

The Economy

  • OBR economic forecasts were based around a material downgrade to the assessment of potential GDP growth. Potential GDP growth is now forecast at 1.6% in 2017 (from 1.9%), 1.3% in 2018 (from 1.8%) and rising to 1.5% by the end of the projection period (from an expected rise to 2.0%). On average, the OBR has reduced its potential growth forecast by 0.5% per annum after this year. Most of this reflected a reduced assessment of productivity growth  now considered around 0.9%, but expected to inch higher to 1.2% by 2022 (from forecasts of 1.4% for 2017 and 1.9% in 2021 in March). This was exacerbated by a reduction in the estimated population growth, although modestly offset by an expectation of average hours worked remaining at current levels.
  • Accordingly, the OBR downgraded its outlook for GDP growth to 1.5% (from 2.0%) for 2017 and 1.4% (from 1.6%) for 2018 and 1.3% (from 1.7%) for 2019. These forecasts are now in line with our own view (1.5%, 1.4% and 1.4% respectively). The OBR envisages GDP growth gradually accelerating to 1.6% by 2022.
  • We also note that the OBR’s UK current account deficit forecasts have deteriorated materially. In the near future the external imbalance is expected at 4.6% of GDP in 2017 (revised higher from 3.5% in March). This is consistent with the downward revisions announced in September, in part reflecting a reassessment of the net international investment position. However, the OBR now forecasts effectively no improvement in the current account deficit over the next six years, the deficit projected to average 4.4% in 2022. In March, the OBR had foreseen this shortfall closing to 2.0% of GDP by 2021. In part, this deteriorating in outlook reflects the increased government spending and borrowing included in this Budget.
  • The OBR also increased its interest rate forecasts. Short-term market rates reflected the earlier than expected hike By the Bank of England in November (OBR forecast the first hike in 2018-19 in March. The short rate profile remains 20bps higher across the next few years, considering this an additional, not simply earlier hike. The OBR has also increased its outlook for average gilt rates by 20bps in each year over the forecast horizon. It has lowered its outlook for sterling: against the euro the OBR now sees sterling around 5% lower over the forecast horizon.


Measures in this Budget


The Chancellor announced a significant loosening in fiscal policy with large increases in public spending announced in a number of key political areas. Today’s announcements totalled a net £25bn give-away between now and 2022-23 (including previously announced policy decisions). The bulk of these (net £15bn) are scheduled for the next two fiscal years. Spending commitments included:


  • Housing and homeownership. The abolishment (80%) or material reduction (95%) of stamp duty for first time buyers alone is projected to cost the exchequer £3.2bn. But additional measures aimed to facilitate the Chancellor’s ambition of building 300k new homes per annum by the middle of the next decade included a land assembly fund, extension of the Housing Infrastructure Fund and additional local authority housebuilding. Total additional housing related spending is forecast to rise by  £9.4bn. 
  • Additional NHS spending. The Chancellor committed an additional £7.5bn in spending to the NHS over the next six years.
  • Measures to cushion the implementation of Universal Credit. An additional £1.4bn spending was forecast to be spent easing the transition to Universal Credit.
  • Fuel & alcohol duty freezes. The Chancellor also chose to freeze duties on auto fuel and alcohol duties at a cost to the exchequer of £5.4bn.
  • Changes in business rates. Primarily this reflected bringing forward the switch in indexation to CPI, as business had asked, at a projected cost of £2.3bn.
  • National Productivity investment funds and increased R&D spending. Both initiatives are to see an additional £9.3bn in spending, but these commitments come towards the end of the forecast horizon.
  • Costs associated with preparing for EU exit. £3bn.
  • Some of these increased spending commitments were offset by increased tax measures. Additional compliance resource to reduce avoidance and evasion, targeting digital company royalty payments, freezing indexation within corporate tax and adjustments to carried interest rules were the largest expected contributors to a slew of measures that are forecast to total £8.9bn in additional revenues to the exchequer.
  • Increases in diesel car tax was increased, but revenue raised here was to go to a Clean Air Fund.  


The Public Finances

  • The public finances are still deemed likely to meet the Chancellor’s fiscal rules, but borrowing has increased significantly. The structural deficit is forecast to fall to 1.3% by 2020-21. This is 0.4% points higher than projected in March, reducing the Chancellor’s headroom on his fiscal target (below 2%) to £15bn, from £26bn in March. Debt as a % of GDP is considered to have peaked in 2017-18 at 86.5% and should fall to 86.4% in 2018-19 and further by 2020-21 consistent with the rule. The welfare cap target was reset in this Budget (the first of a new Parliament) and will apply for 2022-23.
  • The outlook for public borrowing has increased materially. Despite expecting to come in lower than forecast this year and a little lower next year (for a combined £9.7bn improvement), increased borrowing beyond next year sees a total £29bn deterioration in the finances over the next five years. 2019-20 to 2021-22 see a combined deterioration of £39bn, with the new forecast for 2022-23 £9bn higher than the closing forecast in March. The UK’s borrowing is set to continue into the medium term.
  • Public sector net debt is nevertheless lower, benefiting from a reclassification which removed Housing Association debt from the public finances. This (and a modest contribution from the improvement in this year’s finances) have helped the public debt as % of GDP to reach an expected peak of 86.5% in 2017-18, lower than the projected 88.8% envisaged in March. Nevertheless, the higher borrowing profile and weaker GDP growth outlook over the coming years sees this 2.3% point improvement in forecast from March for this year reduced to just a 0.5% improvement by 2021-22. The material one-off improvement resulting from the Housing Association reclassification is all but eroded by the end of the forecast horizon.
  • The structural deficit (cyclically-adjusted PSNB) is forecast to continue to fall over the coming years from an expected 2.3% of GDP in 2017-18 to 1.3% in the fiscal mandate year 2020-21 and 1.1% in 2022-23. This is higher than projected in March where the deficit was expected to fall to 0.9% by 2020-21 and 0.7% by 2021-22. The increased spending has reduced the planned tightening in the fiscal stance. In March the fiscal stance was expected to tighten by 1% pt of GDP and again in 2019-20. This has been reduced to 0.5% next year and 0.3% the year after.  A further tightening in the fiscal stance is not included in the projections with borrowing left higher over the medium term.


Gilt issuance

  • The gilt financing remit saw only modest adjustment for this year. CGNCR for 2017-18 came in £4bn lower than forecast in March, in keeping with a better performance in the broader finances. However, the estimated income from National Savings products was also reduced by £5bn leading to an overall increase in financing needs of £0.9bn, to be financed by additional gilt issuance this year.  With most of the £115bn in gilt issuance now allocated by maturity (only £1.7bn remains unallocated), the bulk of this additional funding appears to have come from short-end issuance.
  • Looking further ahead, CGNCR is expected lower next year than in March (at £45.4bn from £53bn). However, from 2019-20, the cash deficit is expected to be higher than forecast in March. With redemptions also revised modestly higher, gross and net gilt issuance is expected higher than in March. We project gross gilt issuance at £109bn in 2018-19, which would be its lowest absolute value since 2007-08. However, we forecast this rising back to £144bn in 2019-20 and £152bn the year after. Gross gilt issuance remains in excess of 5% over the forecast horizon, and closer to 7% after next year. Net gilt issuance is set to remain in excess of 2% of GDP. 




Notes to Editors

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