UK government provides part two of the ‘kitchen sink’ Covid-19 response

12 Mar 2020

Phil Shaw, Victoria Clarke and Tom Priscott

Investec Economists

Following on from the Bank of England's emergency interest-rate cut, our experts analyse UK Chancellor Rishi Sunak's first budget and his fight to protect the economy against the coronavirus outbreak.

Joined up and co-ordinated (but pricey)

New UK Chancellor Rishi Sunak has endured a baptism of fire in the first month of his new job. Not only did he have to prepare a budget in a few weeks, but it was against a background of dealing with the economic effects of the coronavirus and trying to “level up” the different regions of Britain.
The first point is that the budget came hot on the heels of the stimulus package from the Bank of England earlier in the day. It is clear that the various arms of the UK authorities are working in tandem. UK policy is joined up and co-ordinated, with fiscal, monetary and macroprudential policy all complementing each other. 
The second is that the budget provides a substantial fiscal stimulus to the economy over the next few years. The cost of the measures by 2024/25 is £42 billion, or 1.6% of GDP. The Office for Budget Responsibility concluded that this was the largest planned, sustained fiscal boost to the economy since 1992. In fairness, this includes the £14 billion increase in day-to-day spending for 2020/21 announced by Sajid Javid, Mr Sunak’s predecessor. Overall, both fiscal and monetary policy will help to support demand. The surge in investment will not only bolster demand in the medium term but is a crucial piece of the “levelling up” strategy.
Third, policymakers recognise the fact that the economy will take a hit in the short term. As Mr Sunak himself expressed, we “can’t avoid a fall in demand”. This is as a result of any COVID-19 containment measures in the pipeline, as well as households and businesses putting spending plans on ice for a while. The critical aspect of the policies is that they attempt to stave off a second-round downturn from cash-starved companies and laid-off workers, preparing conditions for a rebound of activity, or a “V-shaped” recovery. Both Mr Sunak and BOE Governor Mark Carney referred to the term “bridge” in terms of policies presented to enable firms to sustain levels of business.
Fourth, it is difficult to assess the budget against a set of fiscal rules. Yes, Mr Sunak confirmed that the measures comply with the framework proposed ahead of the election. Indeed he pointed out that he has a cushion of £12 billion or so in 2022/23, the year when the current budget position is assessed. But these were based on a set of macroeconomic projections that predate the COVID-19 outbreak. The chancellor made it clear that the fiscal framework would be assessed later this year. Indeed we have already noted that the 11 March budget is the first of a fiscal trilogy this year, with a Spending Review set for July and a second budget in the autumn. 
Fifth, we cannot be confident that the recovery will be “V-shaped”, “U-shaped” or even “L-shaped”. Our instinct is to say that after a difficult few months, the 11 March measures help the case to expect the first scenario. In any case, there is further scope for both fiscal and monetary measures if required.
Last, the co-ordinated nature of the policy response is in sharp contrast with other jurisdictions. In particular, although we expect the European Central Bank to ease policy, including cutting the Deposit rate, there is no mechanism to provide the type of response which we have seen from Messrs Carney and Sunak.

Fighting COVID-19 effects and mass scale investment

Mr Sunak had, in what looked to be an impressively co-ordinated response with the BOE, prepared a highly-targeted package. He promised to “do whatever it takes to get our nation through it”. This included a flurry of measures to ease the stresses and strains households and businesses look set to face over the coming months as the coronavirus spreads. The action varied from the inclusion of statutory sick pay for those asked to isolate and cash to help firms with under 250 staff deal with staff off sick, to temporary loans to businesses. There was even an announcement of the scrappage of business rate property taxes for smaller firms for the year. The action complemented steps taken by the BOE earlier in the day, including a Term Funding Scheme for small and medium-sized enterprises (TFSME), which delivers cheap four-year loans, with incentives to lend to SMEs. To read more about this action from the BOE, please click here.
The coronavirus package came as part of a sizeable package of fiscal easing, aimed not just at providing security today, but also delivering “prosperity tomorrow,” which includes the government’s objective of "levelling up across the UK". With everything thrown into the mix, Mr Sunak estimated the UK economy would receive around £30 billion of fiscal stimulus. Coupled with the support announced by the BOE, the action should undoubtedly help in mitigating some of the coronavirus headwinds set to weigh on UK economic momentum in the near term. Importantly, they should, from a future prosperity perspective, help to ensure otherwise good businesses are not wiped out by temporary factors.
We will hear more on the plans to seek prosperity ahead in the upcoming Spending Review in July. The measures today set out the direction of movement amidst huge promises of cash for more roads, a massive step up in investment spending, more money for research and development, and more cash for green objectives such as carbon capture and storage. The step-up in spending is enormous with the chancellor saying he sees the action lifting productivity growth markedly. See below for the detail of the fiscal easing in aggregate, but note that by way of ambition, Mr Sunak intends that by the end of the parliament, public-sector net investment will be triple the average over the last 40 years in real terms. Further detail on specific policy measures announced is listed in Table 3

OBR forecasts - pre-coronavirus

The economic forecasts published by the OBR are of limited use for anyone wishing to assess the near-term economic landscape. One key reason is that they do not build in the significant increase in risk that has emerged as a result of the coronavirus, while still factoring in most of the fiscal policy action. As the OBR says, the outlook is “likely to be significantly less favourable than this central forecast suggests”. Table 1 summarises the forecasts and compares them against a “restated 2019 forecast,” which is effectively the forecast published by the OBR last spring, updated for accounting changes as of last autumn. 
In broad terms, the new forecasts presented are not a million miles apart from the restated numbers. GDP growth for 2020 is seen at 1.1% (was 1.4%), while growth in 2021 was seen a bit stronger at 1.8% (was 1.6%), with growth fading back to 1.3%-1.4% in the last two years of the forecast, a bit below numbers in the restated forecast. Amid all the rhetoric from the chancellor about the productivity boost, the output per hour figures are little changed over the forecast horizon. While the OBR does not tell us how far recent coronavirus developments might have further shifted its forecasts, it clearly warns of the risk of a “deeper – and possibly more prolonged – slowdown”. This statement stands at odds with the optimistic tone taken by the chancellor in his speech.
Budget reaction table 1

Fiscal position – meeting rules, but big deficit?

Mr Sunak announced that a review of the fiscal rules would take place later this year. But for now, the chancellor is standing by the rules explained in the Conservative Party election manifesto late last year. These are:
  • the current budget position should be in balance (i.e. the government should only spend to invest) by 2022/23;
  • public sector net investment should not exceed 3% of GDP;
  • debt service should not exceed 6% of government revenues.
The OBR’s projections show that the current budget target is met with a margin of £11.7 billion, or 0.5% of GDP, while average net investment is 2.9% of GDP. So both of these targets are met. Meanwhile, the OBR assesses that the debt to revenue ratio peaks at 3.5% in 2021/22, meeting the rules comfortably.
What is eye-catching, though, is that the primary measure of the overall public finances, public-sector net borrowing excluding public-sector banks, or PSNBx, reaches £67 billion, or 2.8% of GDP, in 2021/22 (see Table 2). The linking factor is the sheer scale of net investment, which in that year, is well on its way on its trajectory to exceed £70 billion. Of course, this is a policy decision which is instrumental in the government’s policy of "levelling up". 
As mentioned above, the elephant in the room is that the projections were put together before it was suspected that the coronavirus would have such a significant impact on global economic conditions. An updated set of weaker macro forecasts would result in a sharper deterioration in the fiscal metrics and a likelihood of breaking one or perhaps two of the three rules. For idiosyncratic legal reasons, the OBR will update the economic projections and fiscal arithmetic on 13 March, but it has confirmed that these forecasts will not include the implications of COVID-19. That revelation will take place at the autumn budget.
Last, we note that the fiscal rules used in this budget are not those on the statute books, courtesy of the Charter for Budget Responsibility, a legacy from 2017. Indeed, we suspect that Mr Sunak will continue to be as flexible as he feels he needs to in setting and meeting fiscal rules.
Budget reaction table 2
Budget reaction table 3

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