Calm or complacent? Be wary of the “steady as it goes” Budget and plan for a realistic downside.

I told you so…

Other than finding out that Philip Hammond is not great at comedy, what else can we learn from the 2017 Budget? The Chancellor does appear to be a man of his word. He promised to move the main fiscal event to the Autumn and he did not disappoint: this was a budget of few surprises and little policy detail.

…there is nothing to worry about…

Joking his way through the speech, the Chancellor seemed to be a man without a care in the world. Certainly there was no sign he seemed concerned about the potential upcoming negotiations on the UK’s exit from the EU. Quite the opposite, there was no major policy initiatives designed to boost UK economic performance significantly in the short or medium-term.

Maybe the Chancellor is right and we have little to worry about even though the UK has lost its crown as the fastest growing major developed economy to Germany and the OBR’s forecast suggests the UK is losing growth momentum. However, there is a risk that we may be hiding our head in the sand. The OBR did note:

But the Government does not appear to be on a track to meet its stated fiscal objective to “return the public finances to balance at the earliest possible date in the next Parliament”.

In fact, the OBR suggested an ageing population and rising health costs may knock the Government further off target.

…or is there?

There are certainly some downside risks to the OBR’s forecasts for the UK economy. Although the OBR’s forecast of 2% GDP growth is in line with the most recent Bank of England estimate, both are significantly ahead of consensus which is around 1.4 to 1.5%. The OBR appears to expect lower inflation and this supports higher consumer spending in the early part of the forecast period.

However, the element of the OBR’s forecast that doesn’t fit at all with what I am seeing in the corporate world, is business investment. The OBR not unreasonably points out the volatility in the data, but they also note:

“Heightened uncertainty is likely to lead some businesses to put investment on hold”

But then goes on to suggest business investment will bounce back in 2018 and 2019, though these will be the two years when uncertainty about what Brexit will mean will be weighing most heavily on business investment. Yes, it is true that investment has been more resilient than many people thought since June 23rd, but in part this reflects the fact that the UK economy grew strongly in the second half of 2016, there was no sign of a slowdown to concern business. In addition, as EY research shows, businesses were thinking more about their investment three years out than their already committed projects.

This matters a great deal because the OBR is assuming a reasonably strong improvement in UK productivity in the next few years to an annual rate of 1.8% in 2020, compared to 1% last year. If this doesn’t materialise then the long-term growth potential of the UK economy will be smaller than currently assumed.

And let’s not worry about Brexit?

It is also the case that the OBR’s forecast skirts around Brexit. While there is some adjustment for potential disruption to trade after 2019, the OBR assume immigration falls to 185,000, a significantly higher number than previous Government targets. A faster fall could lead to a significant lowering of the forecast.

Be careful out there.

The worst thing to do would be to see “steady as it goes” as a sign that things are in good shape – we just don’t know that is the case. Businesses would be wise:

  • To base plans around consensus GDP growth rather than the OBR’s top end number;
  • To prepare for downside risks from Brexit if investment, trade and migration all move adversely compared to the OBR’s view;
  • To plan for a greater future fiscal squeeze if lower growth, rising care and NHS costs, and Brexit conspire to hit the public finances. National Insurance for self-employed workers, particularly employers’ contributions, appears to be a likely target and employment plans should test out alternative assumptions.

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