Spring Statement reaction – (super) computer says yes to more giveaways...

14 Mar 2019

Victoria Clarke and George Brown

Investec economists

Highlights and analysis on the Chancellor's 2019 Spring Statement

On Wednesday afternoon Chancellor Philip Hammond delivered the second Spring Statement, a year to the day since its inauguration. When this was initially conceived as part of a restructuring of the fiscal calendar, it was billed as being far less intrusive than its
predecessor, the ‘Autumn Statement’, which had in practice been used to tinker with the policy stance.
 
But while the Chancellor broadly stuck to this promise, it was not completely absent of policy action, with key pressure points such as police funding drafted some cash. Amidst what is proving to be yet another key week for Brexitwrangling, the Chancellor used today’s address to reiterate his well-known views on the repercussions of a disorderly departure from the EU.
 
He also repeated that securing a deal would allow him to unleash a “double dividend” to the public finances in the three-year Spending Review (SR19) that is due alongside the Autumn Budget.
 

Weaker growth in the near-term, before firming further out

In its updated projections, the Office for Budget Responsibility (OBR) highlighted that the UK economy had disappointed against its October forecast. Quarterly GDP growth was 0.2% in Q4, half the pace the OBR had expected, and was capped off by a 0.4% month-on-month contraction in December.
 
Partly, this was attributed to the fact that Brexit-related uncertainty weighed on business investment to a greater extent than assumed. Given the weak base this provided for 2019 growth, alongside an assumption that the sluggishness would persist in Q1, the OBR cut its 2019 forecast to 1.2% from 1.6% (Table 1).
 
Subsequently, growth is still expected to come in at 1.4% in 2020 but is now seen as being modestly firmer in both 2021 and 2022 as a flatter profile for Bank rate offsets a softer global trade backdrop. However, the OBR’s revised near-term GDP forecast means it now sees the economy expanding more slowly than its potential in 2019, leading it to now assume that the output gap will turn negative over the coming three years before a return to zero again in 2022. 
 

Table 1: OBR March 2019 macroeconomic forecasts (annual % change unless stated) 

  2018 2019 2020 2021 2022 2023
GDP  1.4 1.2 1.4 1.6 1.6 1.6
OBR October 2018 forecast  1.3 1.6 1.4 1.4 1.5 1.6
Output gap (% of potential GDP)  0.2 -0.1 -0.2 -0.1 0.0 0.0
OBR October 2018 forecast  0.2 0.3 0.2 0.1 0.1 0.1
Productivity (GVA per hour)  0.5 0.8 0.9 1.1 1.2 1.3
OBR October 2018 forecast  0.8 0.8 0.9 1.0 1.1 1.2
Average earnings  3.0 3.1 3.0 3.1 3.1 3.3
OBR October 2018 forecast  2.6 2.5 2.8 3.0 3.1 3.2
Unemployment (% rate)  4.1 4.1 4.1 4.1 4.0 4.0
OBR October 2018 forecast  4.0 3.7 3.8 3.9 3.9 4.0
CPI inflation  2.5 2.1 1.9 2.0 2.0 2.0
OBR October 2018 forecast  2.6 2.0 2.0 2.1 2.1 2.0
RPI inflation  3.3 2.9 2.8 3.0 3.1 3.1
OBR October 2018 forecast  3.5 3.1 3.1 3.2 3.1 3.1
Source: Office for Budget Responsibility

Public Finances improve, for a while…

The picture presented today, based on broad brush Brexit assumptions which would not persist in a disorderly scenario (and might be more favourable still in a ‘smooth’ Brexit), was one in which the expected borrowing position had been reduced throughout the forecast period compared against the October outlook.
 
Indeed, public sector net borrowing predictions had been reduced from a forecast of £31.8bn to £29.3bn in 2019/20, to £21.2bn for 2020/21 (was seen at £26.7bn) with this continuing such that the 2023/24 project was down to £13.5bn (from £19.8bn). 

Table 2: OBR March 2019 fiscal forecasts, £bn (figures in brackets % of GDP)

  2018/19 2019/20 2020/21 2021/22 2022/23 2023/24
PSNBx  22.8
(1.1)
29.3
(1.3)
21.2
(0.9)
17.6
(0.7)
14.4
(0.6)
13.5
(0.5)
OBR October 2018 forecast  25.5
(1.2)
31.8
(1.4)
26.7
(1.2)
23.8
(1.0)
20.8
(0.9)
19.8
(0.8)
Cyclically adjusted PSNBx  24.9
(1.2)
28.7
(1.3)
18.9
(0.8)
15.9
(0.7)
13.9
(0.6)
13.4
(0.5)
OBR October 2018 forecast  28.4
(1.3)
36.0
(1.6)
30.1
(1.3)
25.9
(1.1)
22.2
(0.9)
21.0
(0.8)
PSNDx  1803
(83.3)
1838
(82.2)
1828
(79.0)
1796
(74.9)
1838
(74.0)
1878
(73.0)
OBR October 2018 forecast  1810
(83.7)
1851
(82.8)
1841
(79.7)
1809
(75.7)
1856
(75.0)
1896
(74.1)
Welfare cap and pathway (plus margin)#  122.1 123.8 127.2 131 135  
Welfare spending March 2019 forecast*  119.4 121.6 123 125.9 129.5  
Difference  -2.7 -2.2 -4.2 -5.1 -5.5  
# Welfare cap is set at £131.1bn by the 2022/23 fiscal year. Margin for error reaches 3% in the target year. * Includes an adjustment for inflation. 
Source: Office for Budget Responsibility

Fiscal backdrop

The Chancellor viewed the fiscal backdrop, particularly the improvement in it, as clearing the way (aided by a Brexit windfall if a deal comes to pass) for SR19 to make steps to shore up key foundations of the UK economy for the future.
 
However the actual headroom he has to play with will not be quite as much as today’s headlines imply. Interest and dividend receipts provided a firm helping hand in the improved borrowing projections. But the OBR has warned that student loan accounting changes here could, when implemented, eat up almost half of Mr Hammond’s fiscal headroom.
 
This it said would make a balanced budget harder to achieve. The key change underpinning the improvement in receipts broadly, was the OBR’s assessment that the buoyancy of UK tax receipts would endure, with the income tax and national insurance contribution receipt expectations, clearly supported by the positive assessment of the UK labour market and pay growth.
 
Here it is also worth noting that the OBR now assumes strong income tax receipts (and the downward revision to debt interest on the spending front) are structural improvements, rather than being driven by the position in the cycle. As such, cyclically adjusted net borrowing (as % GDP) has seen more notable revisions that the non-adjusted (headline SNBx) figures.

Amidst a huge amount of Brexit uncertainty and in the context of a Spring Statement, rather than a Budget, Mr Hammond did not want to go further with policy action.
Although the Spring Statement today was not a fiscal ‘event’, the OBR has factored into the forecasts the policy changes that have been announced since the Budget as well as some adjustments to earlier estimates.
 
These represent a string of further giveaways which ramp up slowly over the forecast period, starting from a little over £1bn in 2019/20 up to £2.4bn for the year 2023/24. In the context of the huge fiscal easing announced in the October Budget, these are relatively small, but they serve as a good reminder of the direction of movement of the Chancellor.
 
Additional police funding of £100m for 2019/20 was included within these numbers, but as the Chancellor hinted strongly in his statement, more cash might be to come here for subsequent years. Amidst a huge amount of Brexit uncertainty and in the context of a Spring Statement, rather than a Budget, Mr Hammond did not want to go further with policy action.
 
But he has, as is often the case in any fiscal update/event, set off a range of consultations. These included a consultation on Infrastructure Finance (after ending PFI last year). Mr Hammond also eagerly announced a £79m investment in a supercomputer at Edinburgh University.
 
It is called Archer 2, capable of carrying out 10 thousand trillion calculations per second, something which ‘Spreadsheet Phil’ (namesake of our Chief Economist, Phil Shaw) can also no doubt appreciate. 

Philip Hammond, U.K. chancellor of the exchequer, departs number 11 Downing Street on his way to present the spring statement in Parliament in London
Chancellor Philip Hammond departs number 11 Downing Street on his way to present the spring statement in Parliament 

Phil told fiscal rules OK…

The OBR’s view today was that the borrowing profile still clearly adhered to the fiscal targets set out in the Charter for Budget Responsibility. According to the new projections, the first part of the fiscal mandate (of cyclically-adjusted public net borrowing being reduced below 2% of GDP in 2020/21) was achieved in the 2018/19 fiscal year.
 
This was two years earlier than was required, but was a year later than in the October projections on current output gap projections; nevertheless this was seen as easily achieved. The supplementary debt focused mandate - that public sector net debt as a percentage of GDP is expected to be falling in 2020/21 - was considered to be easily achieved again in these projections.
 
Note though that with the Chancellor plotting some big giveaways later this year, and amidst the accounting changes mentioned above, the headroom will likely be lessened down the road. Finally on goals, the OBR continued its monitoring of the supplementary welfare cap, where welfare spending in 2022/23 needs to be within a cap and margin set by the Treasury at Autumn Budget 2017. There were no major issues to report on this.
 

What next for the Chancellor?

Amidst the continued Brexit wrangling, and uncertainty over Prime Minister Theresa May’s future, there are also ongoing questions over Mr Hammond’s future. His closing remarks in today’s parliamentary address, will not have found him too many friends amongst the Brexiteer wings of the Tory party as he hammered home the need to remove the “threat” of a no deal Brexit.
 
If he survives the next few months, he looks set to launch the Treasury’s Spending Review (SR19) before the summer, which would be presented by the Chancellor alongside the Budget. This, will set departmental budgets, including three-year limits for resource spending.
 
The Chancellor was clear that SR19 will also have a focus on supporting a high-growth economy as he highlighted his ambitions to work for a brighter future. Of course, if Brexit does not go the way Mr Hammond would like, and a more disorderly outcome follows, the/a Chancellor would no doubt make a faster fiscal return to the Commons with an ‘Emergency Budget’.
 
Although Mr Hammond talked today about calibrating policy to avoid sparking inflation in the wake of such events, it is difficult to believe that under a disorderly Brexit the UK government would not look to provide further support. In short, Mr Hammond is set to open the fiscal taps over the coming year, if Brexit passes through smoothly, but even if it doesn’t, further fiscal easing seems likely too.