Philip Hammond’s first and possibly last Spring Budget was a low-key affair. It was also a triumph of competence over charisma, putting the era of George Osborne firmly in the past.
The Chancellor is a fiscal conservative but also a political realist. It showed. He left the deficit reduction path broadly unchanged but did enough on business rates and social care to fend off a revolt.
Economic Backdrop. The Office for Budget Responsibility (OBR) thinks growth will stay around 2% for now but weaken in 2018 and 2019. The official verdict is “cumulative growth over the forecast as a whole [will be] slightly weaker than in November”.
There are many moving parts in an economic forecast but the stand-out feature was slower consumer spending ahead. In the OBR’s forecast, consumption growth slows from 3% last year to 1% next year. Yes, household spending was strong after the EU referendum but only due to rising borrowing and falling savings. The OBR thinks higher inflation, slower borrowing growth and a stable savings ratio will undermine retail spending.
However, there was greater optimism on prospects for net exports and business investment. The former makes sense, thanks to the pound’s more competitive value. The latter is less obvious. The OBR says capital spending growth will pick up from zero in 2017 to nearly 4% in 2018. It does not explain clearly why.
Finally, the OBR has been consistently too optimistic about medium-term growth in recent years. Two years ago, the OBR expected UK growth to be 2.3% in each of 2016, 2017 and 2018: its latest numbers are 1.8%, 2.0% and 1.6%. Slower growth is bad for the public finances and the storm clouds are gathering.
Public Finances. The main story is a windfall in 2016-17 but pay-back in 2017-18, largely reflecting one-off factors and timing effects. Philip Hammond has “looked through” the ups and downs of 2016-17 and 2017-18 to end up with deficits of around £20bn in 2019-20 and beyond. This is a similar end-point to that in the Autumn Statement.
The Treasury reckons the Budget provides a give-away of £1.7bn in 2017-18. The OBR thinks the give-away is larger at £3.0bn. Either way, there was just a little less austerity for the year ahead.
However, another key story is the impact of the budget on the economy. This is best seen in the change in cyclically adjusted budget balance. There is little change between 2016-17 (0.8% of GDP) and 2017-18 (0.9%) which means fiscal policy is neutral. However, in 2018-19 and 2019-20 there are underlying budget cuts worth around 1% of GDP. In other words, fiscal policy will be excruciatingly tight from April 2018 onwards.
This has implications for monetary policy which will need to remain extremely loose. Alternatively, Philip Hammond will be forced to abandon his plans. Like any politician, he is putting off the day of reckoning.
Market Implications. The market reaction was almost zero … a few points up on FTSE 100 and a few basis points higher on the 10yr gilt yield. This budget has few big implications one way or the other for UK markets over the next three to six months. However, farther ahead, the implication is official interest rates lower for longer and probably some sterling weakness.
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