On 18 March 2015 the Chancellor George Osborne presented to
Parliament his sixth and final Budget, 50 days before the 2015 general
election, together with the Office for Budget Responsibility’s economic and
fiscal forecast. It comes at a time when the UK economy is continuing to
The combination of ultra-low inflation,
partly driven by falling oil prices, and recent improvement in earnings has
led to average earnings growing in real terms for the first time since the
start of the recession.
Since the last forecast in December 14,
The OBR state there have been a number of significant developments with
economic and fiscal implications, with further:
sharp falls in oil
substantial net inward
migration to the UK;
falling market interest
According to the OBR the outlook for the
world economy and trade growth are gloomier than three months ago. Although
taken together these appear to have had a relatively modest net effect on
the economic forecast they report:
In almost every budget during this
Parliament the scorecard of ‘giveaways’ and ‘takeaways’ broadly offset each
other. The real action takes place in assumptions for public spending.
The Coalition’s spending assumptions
deliver a tighter squeeze on total spending through to 2018, but then loosen
spending in 2019. The political fox Mr Osborne shot is that total spending
should no longer reach its lowest share of GDP since before WWII. Although
then there is an unrealistic ‘rollercoaster profile’ for spending on public
services: a much sharper squeeze in 2016-18 than seen over the past five
years followed by the biggest increase in real spending for a decade in the
last year of the next Parliament 2019-20.
Sale of Northern Rock and Lloyds Bank
assets helps reduce debt-to-GDP. Enabling Government to say the target of
having national debt fall as a proportion of Gross Domestic Product
at the end of this Parliament is met. Net debt is expected to fall by a tiny
fraction between this year and next, rather than rising by 0.8% as shown in
the OBR’s December forecast.
Growth of UK economy
Real GDP growth of 2.6% in 2014
as a whole was the most since before the recession in 2007, supported by a
combination of investment and consumer spending. Falling oil prices have led
to inflation falling to 0% and widely expected to lead to real household
incomes rising strongly in 2015, underpinning further growth in consumer
The starting point for the OBR forecast
is a weaker picture than previously reported by the Office for National
Statistics (ONS), which has revised down its measurement of growth from the
first quarter of 2013 to the third quarter of 2014 from 5.1 to 4.5%.
The broader picture of annual growth remains healthy:
During the recession 2008/2009 GDP
fell by 6.0%. A steady recovery over the rest of 2009 and 2010, gave way
to weaker growth in 2011 and stagnation in 2012 with growth returning at the
start of 2013.
Growth from 2010 to 2014 has been driven
by domestic demand: consumer spending was up by nearly 6%, government
consumption rose by 4%, and investment increased by around 17%. While
exports rose by 10%, the contribution to growth was offset almost entirely
by a near 10% increase in imports.
The services sector – which dominates the
UK economy, accounting for 80% of output – has grown significantly since
2010. As a whole, the
sector has grown by 11% and is now 8% above its pre-recession peak in 2008.
Until recently, a resurgent housing
market and improved credit conditions and confidence have supported
increases in consumer spending despite average earnings growth being lower
than inflation. According to the ONS, real household disposable income per
head is the same as 7 years ago.
The OBR’s central GDP projection of
2.5% GDP growth for 2015
is somewhat weaker than the Bank of England’s at 2.9%, but they appear to
agree that there is likely to be strong consumer spending growth in 2015
whereas it had been expected to slow.
potential output of economy
Nevertheless, although GDP is reported as
3.4% above the highest level seen before the recession, when
adjusted for population growth,
GDP is still 1.4% below its
pre-recession peak, almost
seven years on. One principal reason is the continuing weakness in labour
productivity. GDP per head has been flat since 2007, historically annual
productivity growth has been around 2%, the same rate as GDP per head - a
measure of living standards. The recent period of productivity stagnation
raises unanswered questions.
For the OBR, the growth of potential
productivity remains below its historical average throughout their 5 year
forecast reflecting slow normalisation over some years following the near
collapse of the financial system. But they say since it is difficult to
explain the abrupt fall and persistent weakness of productivity in recent
years, it is also hard to judge when or if productivity growth will return
to its historical average, which in turn affects the potential of the
economy for growth.
The OBR estimate a gradual strengthening
of potential output growth over the next five years, but have a
pessimistic estimate of spare capacity or gap between actual and
potential output. The Bank of England’s Monetary Policy Committee view of
‘slack’ is currently in the region of ½% of GDP, while the OBR’s estimate of
the output gap is narrower at 0.4%.
UK labour market
has also continued to surprise economists in the last five years. Following
a dip in 2011, UK employment has been growing strongly since the spring of
2013 and remains at a record high: 30.94 million people (73.3% of
people aged from 16 to 64) were in employment at January 2015, 617,000
more than for a year earlier; 1.9 million more than May 2010. Most of this
employment growth is attributable to more full-time workers: 481,000 more
than last year. Extraordinary, since the economy has grown less in the last
five years than the OBR thought it would.
There are 1.86 million unemployed
people, 479,000 fewer than for a year earlier. Reported unemployment in
June 2010 was 2.47 million people.
On the other hand pay growth has
remained muted, consistently lagging behind inflation growth, until
recently. Average pay was 1.7% higher excluding bonuses in the three
months to December 2014 compared to the year before. By comparison,
over the same period averaged 0.9%.
Upon coming to power in May
2010 the Coalition made control of the public finances its raison
d'être. Going further than Labour’s measures by announcing tax increases, in
particular VAT, with cuts to social security and spending on public
services. These ‘austerity’ measures were expected, by the end of this
Parliament, to have debt falling as a % of GDP and reduce the deficit
to 2% of GDP.
In that respect the plan did not succeed
since tax revenues fell consistently and considerably short of expectations,
particularly for income tax, ground which the OBR consider cannot be
recovered and will necessitate further substantial spending cuts in the next
Parliament to balance the budget. Each of the main Westminster parties is
committed to reducing the deficit following the largest peacetime economic
shock in living memory.
The deficit may have since been halved,
but public borrowing remains, pre-election, at £90 billion
annually or 5% of national income (GDP)
this year (2014-15), which the Coalition
has reduced from its post-war peak of an annual deficit of £153 billion or
10.2% GDP in 2009-10.
At March 2015, national net debt of
£1,479 billion (80.4% GDP) is much greater than predicted in June 2010
of £1,284bn around £200bn higher than originally hoped for, but importantly
for Government finances the cost of servicing the national debt has shrunk
over the last five years. Much lower interest rates than envisaged in 2010
have lightened the burden of deficit reduction.
Net debt (PSND) was £956 billion
(62% GDP) at the end of 2009/10 and at the time of the Coalition coming to
power, the increase over the life of this Parliament is £523 billion or over
In December the Government’s outline plan
for total expenditure implied public spending would fall to 35% GDP
in 2019-20. A loosening of spending in 2019 would take it to 36% of
then in kilter with current levels of tax
revenue and government receipts, but possibly not with the historical
average for spending that is in the region of 40% of GDP.
Real government consumption is
estimated to have grown by 1.5% in 2014. Relative to the size of the
economy, nominal government consumption is forecast to fall from 19.7% of
GDP in 2014 to 16.1% of GDP by 2019. This is less of a fall than the OBR
forecast in December, but would still leave government consumption as a
share of GDP equal to its level in 1964.
The OBR point out that, apart from 2019,
the main reasons for lower spending in this March 2015 forecast are lower
inflation and interest rates, which reduce debt interest payments and
Since December, interest rate
expectations have fallen significantly. The first increase in Bank Rate
is now expected in mid-2016 rather than late 2015. Bank Rate expectations
are 0.5 percentage points lower than in December for the first quarter of
2020, only reaching 1.7% in five years’ time, whereas Bank Rate had
been implied as 2% in 2019. New mortgage rates have fallen significantly
since mid-2012, the OBR expect effective mortgage rates to fall further in
the near term and then to rise only slightly over the next five years.
The Treasury report that there continue
to be signs of normalisation in the housing market although house prices
grew by nearly 10% in the year to December 2014 (compared to 5½% to
December 13). The OBR expect house price growth to average 6% annually over
the next five years.
The price of Brent crude oil
reached an all-time high above $145/barrel in July 2008. In January 2015 it
fell to its lowest level in six years at $46.
Oil is a key global commodity which gives
an important indication in the absence of changes in supply about global
demand. The OBR judges that the fall in oil prices reflects both
lower-than-expected global demand and higher-than-expected global supply of
One consequence is that the OBR’s
forecast for CPI inflation
has been revised down significantly since December, primarily reflecting the
implications of sterling oil prices.
Concerns about deflation affecting the
Eurozone seem less relevant to the UK economy. While UK inflation, as
measured by the CPI, has fallen from just under 2% in June 14 to 0% in
January 15, inflation has not yet turned negative, although the Bank of
England now expect it to do so in the first half of this year 2015.
Perhaps the main reason to be relaxed is
that the current ultra-low level of inflation has a specific cause, the
steep fall in the oil price, rather than reflecting more widespread
declining prices across the economy as a whole