Any signs of Rebalancing – what will the EY ITEM Club make of the Budget?

A Budget for change?

The Ernst & Young ITEM Club used its pre-Budget Report to urge the Government to borrow £10 billion in each of the next two years to invest in infrastructure, estimating that this would add 0.5% to GDP in each year and pay for itself in the form of lower borrowing within three years.

But the call fell on deaf ears. The Chancellor presented a Budget with lower levels of infrastructure investment – which would take years to come to fruition –  plus a range of changes to the Corporate and Personal tax regimes and provided an unexpected boost to the housing market.

The Ernst & Young ITEM Club’s Spring forecast for the UK economy will be published on Monday 15th April. This will be the first independent forecast since the Budget and I am very keen to see how ITEM expects the outlook for the UK economy to have changed. In particular it will be fascinating to see if the forecast suggests that the Chancellor has advanced the much heralded rebalancing of the UK economy: a shift from a reliance on house price and debt fuelled consumer spending to growth driven by business investment and exports.

Solving the wrong problem?

My concern is that the Chancellor hasn’t addressed the real challenges facing the UK economy and is trying to solve the wrong problem.

The Chancellor began his Budget speech with a clear statement of intent, “Putting right what went so badly wrong”. Without doubt, some things did go wrong and need fixing: consumer indebtedness remains way above historic norms; inflation remains stubbornly above the 2% CPI target; several banks have had to be bailed out; the Government deficit reached 11.2% of GDP in 2009/10; and export growth remains sluggish despite a weakening pound.

Government still needs to tackle the UK’s crisis of confidence

The challenge however is not just about rectifying the problems of the past: the UK economy is at best stuck in neutral and may be in permanent decline, with its productive capacity declining. As -the OBR noted, the Eurozone economy is “fragile” and the UK economy is still below its pre-crisis GDP level. This is no normal recession – the UK is recovering more slowly than from any other recession in living memory. The result is that business and consumer confidence has collapsed and neither group has sufficient belief in the strength and sustainability of economic activity to make long term commitments.

What we have is a crisis of confidence. Businesses are hoarding record levels of cash and increasing dividends and share buy backs but are refusing to commit to even “normal” trend levels of investment, never mind the higher levels that typically characterise economic recoveries. While consumers have increased their savings rates to levels unseen for two decades or more. The economy has been flat for so long that risk aversion has become embedded in behaviour and historic relationships have broken down: confidence will need to be higher than in previous recessions before consumers and businesses will take risks. Achieving economic growth will require much more effort than was sufficient at similar points in previous recessions.

Evaluating the Budget

So the key questions, I will be looking for answers on in the EY ITEM Spring Forecast are:

  • The growth in business investment, will the Chancellor be able to get business moving and using its cash piles to invest?
  • Will the UK’s export performance improve? The USA, China and developing markets are returning to good growth rates, will the UK be able to capture some of this opportunity?
  • Is finance for business, especially SMEs, expected to become more readily available? Will this be on reasonable terms?
  • Is inflation likely to fall back towards the target of 2% any time in the near future?
  • What is the outlook for employment?  Will we start  to see any acceleration in the creation of higher paid, full time jobs?
  • What are the prospects for consumer spending and the housing market? Has the Chancellor created a new paradigm?

The challenge for the Chancellor was to use the Budget to create momentum to move the UK economy forward and drive the major transformation required to position us for future success. The Ernst & Young ITEM forecast will provide the first quantitative analysis of how successful his Budget is likely to be.


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