On Tuesday 13th March 2018 the
Chancellor Philip Hammond presented to Parliament the Office for Budget
Responsibility’s (OBR) economic and fiscal outlook, setting out their
forecasts to the year 2023. The OBR’s duty is to examine and report on the
sustainability of the public finances.
True to his word, the Chancellor announced no new fiscal
policy measures in his Spring statement, following last November’s ‘first
Autumn Budget’, under the new Parliamentary schedule, designed to end tax
announcements being made twice each year.
Relatively little time has passed since the November forecast
and the outlook, for the UK economy and public finances, looks broadly the
same. The OBR said the economy has slightly more momentum in the near term,
related to the strength of the world economy, but they have not changed
their view of the UK’s growth potential, for the medium-term.
Increasing GDP growth for 20 consecutive quarters
UK consumer confidence may have ebbed in February and the
vote to leave the EU may have slowed the economy, but in the opinion of the
OBR, this has been much less than expected. This is thanks, they say, in
part to the willingness of consumers to maintain spending by reducing their
The present backdrop of a generally
stronger global economy has led prominent forecasters, including the Bank of
England, to raise expectations of UK GDP growth for 2018, to between 1.5%
and 2.0%. The OBR has followed suit.
Although concerns over long-term productivity growth, a
casualty of the 2007/08 financial crisis, caused the OBR to downgrade the
forecast of medium-term economic performance last November. The OBR’s new
GDP growth forecast is revised for the slightly better outturn in data for
2016/17 and is now tweaked for faster growth in 2018 (1.5% compared with
The latest headline statistical measure shows real GDP growth
decline to some extent from 1.9% in 2016 to 1.7% in 2017.
2007 to 2017
Source ONS: IHYP February 2018
Critics suggest this weakening of UK growth, in the face of
the world’s recent accelerating economic growth, including the US and Eurozone, may be attributable to Brexit.
The OBR say the UK’s performance broadly supports their
forecast judgements made in November 2016, following the referendum vote to
leave the EU. The OBR expected:
• net inward migration to slow, which it has, from over
330,000 to just below 250,000, annually;
• sterling to fall and raise inflation, although inflation
has risen more than forecast, consumer consumption has held up better than
• uncertainty around the Brexit negotiations between the UK
and EU to weaken business investment, the Bank of England report business
investment as 3% to 4% weaker than before the referendum, but this has also
held up better than the OBR had expected;
• lower sterling to deliver a boost to the economy through a
greater contribution from net trade, whereas this offset has been smaller
than expected because imports are meeting a greater share of domestic
The big story for the OBR in November was the economic
judgement to assume that potential productivity growth would be weaker in
their forecast than previously assumed. This was a reflection of actual
productivity growth since the financial crisis and the fact that this
appears to be a global rather than purely domestic phenomenon.
The surprise since November is that productivity growth –
measured as output per hour – has been stronger, through lower average hours
worked. For the present the OBR believe this is owing to statistical error
rather than reality. The same being true of a similar change in mid-2011.
The breakdown of the relationship between employment and
productivity remains. Productivity growth has been much weaker than for
decades before the Crash. Output per hour has risen by just 0.2% each year
since 2008, compared to an average of 2.1% a year over the preceding 35
years. The pattern of unexpectedly strong employment growth and unexpectedly
weak productivity growth continues as a consistent and constant feature of
economic forecasts since the 2008/09 Crash.
The OBR conclusion is that there has been little change to
the economy’s underlying growth potential.
In terms of the prospects for actual GDP growth, the OBR
assess whether activity in the economy is running above or below the level
that can be sustained without upward or downward pressure on inflation,
which determines whether actual GDP will grow more or less than potential
In that respect the OBR’s measure of the ‘output gap’ is that
the UK economy is running a little above potential, judging from the latest
surveys of capacity and recruitment difficulties, and of stiffening wage
The caveat being the uncertainty in any measurement of an
economy’s potential output.
Hence, owing to the unexpected strength of the world economy
the OBR have revised their near-term assessment, but due to the suggested
absence of capacity, cautiously believe that the medium-term growth
potential is unchanged and that expected growth of the UK economy
consequently weaker. This they expect to become manifest through lower
growth in household consumption, in line with income growth, subdued
business investment and neutral net overseas trade, from 2020 onwards.
Although the OBR have not changed any assumptions about the
impact of Brexit on the UK economy, they have quantified the financial
settlement or ‘divorce bill’ that was provisionally agreed with the EU last
year. This settlement, they estimate, will total around £37 billion, in the
middle of the range estimated by the Treasury.
Inflation and monetary policy
Headline inflation decreased to 2.7% in
February 2018 from 3%. The decrease was due to falls in the price of food,
as a key driver of inflation, transport and restaurants/hotels, partly
offset by increasing prices of clothing.
The fall in the value of the pound since late 2015 and
following the EU referendum in June 2016 has caused higher import prices,
which were probably passed onto consumers. The OBR now expects consumer
price inflation to fall below 2%, in a year.
The current level of inflation, above 2%, is seen by the Bank
of England as almost entirely due to the effects of higher import prices
following sterling's depreciation.
In 2017, the UK’s exports of goods and services totalled £622
billion and imports totalled £651 billion; an overall trade deficit of £29
billion in 2017. The EU accounted for 43% of UK exports of goods and
services and 54% of imports in 2016, resulting in a trade deficit with the
EU of £80 billion in 2016 counterbalanced by a trade surplus of £39 billion
with non-EU countries.
The Bank agree the contribution of import prices to inflation
has probably peaked, which combined with a rise in nominal pay growth should
support a recovery in household real income growth.
However, the Bank also
share the view that there is little capacity in the UK economy and while
interest rates are unchanged at 0.5%, the first increase in a
decade having come in November 2017, many observers believe there is a good
chance that rates will be raised at the next MPC meeting in May 2018.
Nevertheless, the UK labour market continues to grow, and
32.25 million people were in
employment in the three months to January 2018, up 168,000 from the previous
quarter and up 402,000 from the previous year. 75.3% of people aged
from 16 to 64 in the UK, the highest rate since comparable records began in
1971. Unemployment continues to fall and is at its lowest statistical point
The UK unemployment rate is just below the rate of the US,
below that of France, but above that of Germany. The UK rate of unemployment
is the 9th lowest of the 35 OECD member countries.
earnings were 2.8% higher in the three months to January 2018
compared with the previous year. There are signs earnings are starting to
grow more strongly, with falling inflation this is relieving the recent
‘squeeze’. The Bank’s survey reported recruitment difficulties in 2017 and
the average private sector pay settlement is expected to be just over 3% in
Annual borrowing by Government has fallen considerably since
the high levels reached following the Crash. Borrowing has decreased from a
peak of £153 billion in 2009/10 to £46 billion in 2016/17, equivalent
to 2.3% of GDP.
Borrowing is now expected to be nearly £5 billion lower this
year, then expected in November, at around £45 billion (2017/18).
The OBR attributes much of the forecast fall in borrowing
between 2017/18 and 2022/23 to reductions in departments’ day-to-day
spending on public services.
The OBR conclude that the economy and public finances have
both performed somewhat better in the last few months than they had expected
in November. Yet the medium-term outlook and the Chancellor’s room for
manoeuvre against his fiscal targets are, they consider, little changed.
Although the OBR judged that the Government is on course to
meet targets for structural borrowing, debt and welfare spending, meeting
the Government’s overall objective for the public finances “looks
The Coalition Government’s fiscal mandate was to balance the
structural current budget balance, which excludes borrowing to finance net
The current looser fiscal mandate requires the Government to
bring the structural budget deficit below 2 per cent of GDP by 2020-21. Over
the past 12 months, the current budget has recorded a small surplus, but
allowing for uncertainty the OBR see roughly a 65% likelihood of balancing
the structural deficit based on current policy.
Public sector net debt, the stock
of overall Government indebtedness, arising from past deficits, was
equivalent to 85% of GDP at the end of 2016/17, a debt-to-GDP ratio not seen
since the mid-to-late 1960s.
10 April 2018