Budget sees Chancellor between a rock and a hard place as OBR cuts productivity forecast


The Chancellor is in an unenviable position heading into the Budget, facing pressure for ‘bold action’ that stems from some public dissatisfaction with austerity measures, and squeezed public sector pay, while also having to contend with anticipated higher budget deficits over the medium term, according to the EY ITEM Club Budget preview.

The good news for the Chancellor is that public finances performed markedly better than anticipated in the March Budget over the first six months of fiscal year 2017/18. Indeed, if the April-September performance was replicated over the full fiscal year, 2017/18, public borrowing would come in at £42.4b compared to the shortfall of £58.3b forecast by the Office for Budget Responsibility (OBR) in March’s Budget.

While the EY ITEM Club doubts that the first half rate of improvement will be sustained, we suspect that the 2017/18 shortfall will significantly undershoot at around £51b. Even though this is a welcome development for the Chancellor, his room for manoeuvre in the Budget is set to be severely constrained by the OBR cutting its productivity forecasts.

Stuart Wilkinson, tax partner at EY in the East comments: “The squeeze on available resources couldn’t have come at a worse time for the Chancellor and the UK economy. Growth is slowing and business confidence is falling and the UK needs to invest to prepare for Brexit, as well as adjust to technological change. We need the Government to lay out bold measures that could improve the business investment climate, increase productivity and improve supply chains, but the chances of a bold Budget are slim.

“Nevertheless, the East of England is well placed to continue to receive a good share of the UK’s inward investment and if high-growth firms are targeted there are plenty of candidates in this region.”

Howard Archer, chief economic advisor to the EY ITEM Club comments: “The major fly in the ointment for the Chancellor this Budget is that the OBR has already announced that it will “significantly” downgrade its assumptions for UK productivity growth over the next five years in its forecasts for the Budget. This reflects the fact that the OBR has repeatedly assumed in recent years that there will be a marked pick-up in the UK’s productivity performance which has failed to materialise. Consequently, the OBR has now come to the conclusion that some of the temporary factors that it believed were holding back productivity are having a permanent impact.

“It therefore seems probable that the OBR will reduce its GDP growth forecasts for the UK and appreciably lift its Budget deficit projections. In March, the OBR indicated that the Chancellor had a buffer of £26b if he was to meet his target of bringing the structural budget deficit below 2% of GDP in 2020/21. This looks likely to be substantially reduced. It also looks increasingly questionable as to whether the Chancellor can achieve a balanced budget by the mid-2020s.”

Chancellor reluctant to abandon fiscal targets

There is growing demand from some sections of the economy to increase levels of public spending, as well as pressure from some business organisations to implement measures to foster investment and boost productivity. However EY ITEM Club says that the Chancellor seems set to remain committed to the fiscal targets he set out in the Autumn Statement in November 2016. This could limit the potential for significant Budget giveaways – unless they are funded by revenue raising measures found elsewhere.

Howard Archer adds: “The Chancellor is getting squeezed on both sides. He is under pressure to increase levels of public spending, but he now faces larger deficits over the medium-term and he has to square the circle. It therefore looks most likely that the Budget will be relatively low-key and largely reliant on low-cost measures. The Chancellor has indicated that his priorities will be on boosting the housing market, helping consumers and supporting high-growth firms which are short of finance.”

If he has the appetite, the Chancellor could choose to take some bold measures in the Budget while maintaining fiscal discipline. However, this would necessitate rebalancing measures. For example, the Chancellor is reportedly considering the promotion of “intergenerational fairness” through cutting National Insurance Contributions for younger workers and financing it by restricting pension tax relief for older workers.

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