Spring 2020

Post Brexit Budget overtaken by events

On Wednesday 11th March the second new Chancellor, Rishi Sunak, presented the first Budget since the UK formally left the EU on the 31st January 2020. Last March, there were no announced changes to the tax system. There was no Budget in 2019, owing to the Brexit impasse and as a consequence of the General Election. 2019 was the first calendar year without a UK Budget since before 1900.

In 2019, the House of Commons voted against Theresa May’s Brexit deal three times. Nevertheless, the then European Commission President, Jean-Claude Juncker, reiterated the position was “not open for renegotiation”. On the third occasion of defeat in the Commons, it meant that the UK was unable to leave the EU, as planned on 29 March 2019. Mrs May’s subsequent resignation came after electoral defeat (23 May 2019) with the Brexit Party wining most votes in the UK European Parliament election. The new Prime Minister Boris Johnson announced the mission of his new Conservative Government to leave the EU by 31 October: "come what may".

Owing to a majority in Parliament opposed to withdrawal without an agreement, this was to be in the face of opposing MPs taking control of the order paper in the Commons, the Fixed-term Parliaments Act 2011, and a Supreme Court decision declaring Parliament’s proroguing as having been motivated by an improper purpose, that of stymying Parliamentary scrutiny.

Following a new Brexit deal dealing with the backstop, the Commons sat unusually on Saturday 19 October, but this was lost on amendment causing the Prime Minister to write to the EU. The Commons’ Speaker ruled that there should be no further debate. With a Brexit extension to 31 January 2020 announced by the EU, eventually by 30 October 2019 deadlock was broken with the passing of a Bill, settling the date of a General Election as at 12 December. The first December general election since 1923.

An overall majority was won by Boris Johnson leading the Conservative Party, taking 365 seats, a majority in Parliament of over 80 seats, and the highest share of vote for any single party since that of Margaret Thatcher in 1979.

The UK ceased to be a Member State of the European Union with the coming into force of the Withdrawal Agreement on 31 January 2020 at 11pm GMT.

That treaty governs the current relationship between the UK and the EU. This change in relationship with the EU has had major domestic and constitutional consequences for the United Kingdom. The UK is currently in a transition period during which nearly all EU rules will continue to apply. The revised UK-EU Withdrawal Agreement was accompanied by a non-binding Political Declaration setting out a framework for a future relationship.

The March 2020 Budget was launched by Mr Sunak as concerns for public health and economy began to take hold. Severe acute respiratory syndrome coronavirus 2 (SARS-CoV-2), a coronavirus, emerged from Wuhan, a city in eastern China, in December 2019. By 30 January 2020, the coronavirus disease causing serious pneumonia was declared a public health emergency by the World Health Organisation (WHO), the sixth such emergency since 2009.

As Mr Sunak prepared for the Budget, the UK economy appeared to be on the up, with business and consumer optimism increasing and a recovery in retail sales.

In February 2020, uncertainty in the UK economy was giving way to optimism in services and manufacturing. There had been a reported improvement in UK manufacturing activity, generally seen as a solid expansion of the manufacturing sector. The Confederation of British Industry’s (CBI) survey showed that more manufacturers had expected future output to grow rather than shrink. The Purchasing Managers’ Index for services had risen sharply to its highest level in over a year (since September 2018). In 2019, services accounted for around 84% of UK workforce jobs.

The seasonally adjusted IHS Markit / CIPS Flash UK Composite Output Index was unchanged at 53.3 in February and comfortably above the threshold (50.0) that separates expansion from contraction.

UK Retail sales also recovered slightly, with sales volumes in January and February up 0.8% on a year before. At the January 2020 meeting, the Bank of England’s Monetary Policy Committee (MPC) voted 7-2 to leave interest rates unchanged.

Hence, on the eve of the UK’s withdrawal from the EU, economic growth continued, recession looked unlikely, there were record numbers of people in employment, the unemployment rate was at a historic low, earnings on average were growing faster than inflation and inflation remained steady (at 1.8%). Average earnings had finally exceeded their 2008 pre-financial crisis levels.

The outlook was at least satisfactory with the Treasury’s survey of independent forecasts showing an average forecast of 1.2% GDP growth in 2020 (reported growth in 2019 was 1.4%).

UK Gross Domestic Product yearly since 1949

The labour market ended 2019 with the highest employment rate (76.5%; 32.99m people) and joint-lowest unemployment rate (3.8%) since comparable records began in 1971. Average earnings growth slowed over the second half of 2019 from 4% to just below 3% but remained comfortably above inflation.

At the end of February 2020, public sector net debt was equivalent to 79.1% of GDP which is lower than at the end of February 2019, when the debt-to-GDP ratio was 80.2% of GDP.

Although a year having passed since the OBR’s last full forecast, and political turmoil of Brexit, the OBR say the near-term economic outlook at the time of closing their forecast appeared little changed. That, of course, has been overtaken by the spread of the coronavirus disease.

The February figures for GDP output and public debt are almost certainly the last that will have any semblance of normality as the closure of much business means that output in March and April “will fall at a speed and magnitude that the UK economy has never endured before."

The first reported case in the UK was on 31 January 2020. On 23 March the Prime Minister announced a ‘lockdown,’ a policy for the closure of non-essential shops and social distancing.

Statistics suggest the UK economy is heading for a recession deeper than the 6% contraction in GDP of the 2008/9 financial crisis and possibly the most severe since 1900.

Mid-March data from IHS Markit, compiled before the lockdown announcement, confirmed that the UK economy had already been dealt a more severe blow than at any time since comparable figures were first available over 20 years ago. The combined monthly decline in output across manufacturing and services already exceeded that at the height of the global financial crisis. The index is reported at 37.1 in March, down from 53.0 in February 2020.

Central forecasts for GDP growth or contraction, based on modelling as used by the OBR, are less useful during a period of such economic disorder and the OBR’s predictions may even have been rendered useless owing to the high and significant degree of uncertainty. Initially in mid-March, a recession may have been expected with a 2.5% fall in GDP.

Estimates are now that GDP may fall by between 10% and 20%, and informed comment [Capital Economics] says “that it is now looking unlikely that the economy will rapidly bounce back once the Covid-19 pandemic improves” owing to the scale of “job losses and company failures” taking place.

Whereas the CBI survey had previously showed that manufacturers had expected future growth in output, the March survey reported a sharp reversal (a difference of -20% of manufacturers from +8% in February, the lowest level since May 2009). A special interim survey measurement of consumer confidence (16-27 March) from GfK NOP showed the overall consumer confidence index declining by 25 points to -34, the largest fall in the index since the survey began in 1974.

Retail footfall in the UK was around 80% lower at the end of March and beginning of April in comparison with the same period last year.

A myriad of data sets suggest contraction is set to be one of the deepest recessions since 1900.

Clearly the spread of the coronavirus disease is causing significant disruption to the UK and global economy. What started as a local Chinese health emergency has become a global one causing an economic calamity. In this context, discussion of productivity growth and the output gap pales into insignificance.

Robert Chote, Chairman of the Office for Budget Responsibility, introduced the OBR’s presentation saying that the OBR’s forecast figures do not reflect latest developments. The OBR provided the Treasury with a stable forecast baseline in mid-February to prepare the Budget. The widespread effect of the spread of coronavirus disease was then expected to be relatively limited. In the March 2020 Budget, the Government announced a new set of fiscal objectives and the largest giveaway Budget since 1992, for reasons unconnected with the epidemic.

The key goal of the emergency measures is to offer a financial bridge over the current cash shortfall. The Chancellor also announced tax measures, several of which were included in the Conservative manifesto.

Government borrowing has decreased from the peak reached following the 2008 financial crisis. Annual borrowing peaked at 10.2% of GDP in 2009/10. Borrowing, before the coronavirus disease, had settled at a level more typical of the post WWII era. At 1.8% of GDP, borrowing was below an average of the last 70 years.

The Johnson administration has a different mandate, coming from the Conservative manifesto and, in the Budget, wanted an “infrastructure revolution” to be financed by borrowing. Despite the relatively high levels of public debt compared to the period during and immediately after WWII in the 1960s, the UK Government’s debt interest costs have remained relatively low. The markets have been prepared to lend at historically low rates.

Relative to the OBR’s baseline forecast, the Government’s spending decisions in the 2020 Budget increase the annual deficit by nearly 1 per cent of GDP on average over the next five years. These plans are rooted in the assumption that its borrowing costs will remain relatively low, as market expectations indeed suggest. Rather than aim for budget balance and a clear decline in the debt-to-GDP ratio the Johnson administration is content to borrow.

Without the pandemic this may have looked sustainable over the medium term on current interest rate and growth forecasts. But as the OBR pointed out financing conditions may not remain this favourable and the public finances are more vulnerable to adverse inflation and interest rate surprises than they were. Yet, this statement from the OBR was before lockdown, and the economic calamity in the wake of the pandemic.

On the 14 April 2020 the OBR issued a statement, titled the "coronavirus reference scenario", an illustrative scenario of the UK economy's outlook in the throes of the pandemic, which stated that "real GDP falls 35 per cent in the second quarter, but bounces back quickly." and that annual borrowing increases dramatically to reach 14 per cent of GDP before falling back... "the largest single-year deficit since the Second World War."

In 1946/47 after WWII the scale of public sector net debt was 259% of GDP or over 2½ times GDP. Nevertheless the unanswerable question remains in view of the scale of crisis, to what extent we are now heading for a comparable level of public indebtedness.

Anthony Denny
14 April 2020