UK Reaction: Budget sees Chancellor Hunt lay out considered growth strategy
- 16 March 2023 (10 min read)
• The Office for Budget Responsibility (OBR) no longer sees UK economy falling into recession. GDP outlook raised by 1.2 percentage points (ppt) and 0.5ppt in 2023 and 2024.
• Firmer growth outlook and fall in wholesale energy costs improves outlook for finances.
• Public sector net borrowing (PSNB) is forecast to be £25 billion lower in 2022-23, to be £50 billion lower over forecast horizon even after increased spending.
• Chancellor uses fiscal windfall to increase spending by around £20 billion per annum for the next three years.
• Avoiding a give-away that boosts demand, the Chancellor aimed to address the UK’s structural weaknesses.
• Business investment incentives were maintained with a temporary, 3-year, full-expensing capital allowance.
• Labour supply issues were targeted with measures focused on childcare provision, disability allowances and pension contributions.
• Additional measures to ease cost-of-living pressures were also enacted.
• The OBR expects the government to meet its fiscal rules.
• The UK’s debt outlook is much improved, expected to peak this year at 103% of GDP, some 3.5ppt lower than in November.
• Gilt issuance is still expected to rise next year, but is no longer expected to be record-breaking.
• Financial market reaction was entirely focused on broader banking concerns.
Overview – Improved finances outlook allows medium-term growth strategy
Although this was Chancellor Jeremy Hunt’s second fiscal statement, following the Autumn Statement on 17 November, the traumas of previous Chancellor Kwarteng’s fiscal event in September still echo and it was important that today’s Budget proceeded smoothly and as uneventfully as possible. In this regard, further concerns about global banks dominating financial markets today may not have displeased the Chancellor, resulting in a relative lack of focus on his statement. That said, Chancellor Hunt appeared to convert an improved outlook in the finances into a considered, medium-term growth strategy that focused on concrete improvements to potential growth.
The Chancellor was helped in today’s statement by a number of related developments: wholesale gas prices have eased materially, the spot value down two-thirds from the time of the last Budget and 80% from August’s peak; the economy avoided recession in the second half of last year and the OBR forecast it to avoid recession in 2023 – albeit by the same narrow margin it was avoided in 2022. However, the OBR’s growth forecast has improved by some 1.2ppt for this year. And the public finances outlook has improved on estimates last year – the OBR estimating this year’s deficit will be £25 billion lower than four months ago and £50 billion lower over the forecast horizon, even allowing for a range of new measures.
This provided the Chancellor with some scope for fiscal manoeuvre to address the most pressing needs. The Chancellor announced a £3 billion extension to the Energy Price Guarantee (EPG) – extending the energy price fix at £2500 until July. An increase in Defence Spending, up by £5 billion over the next two fiscal years, provided for increased security commitments. He was also able to carry out the Conservative Party’s annual override of the fuel duty escalator as well as extending the 5p duty reduction for another 12 months, at a cost of £5 billion next year and £2.5 billion thereafter. This was added to a number of measure aimed at easing the cost-of-living squeeze this year.
Additionally, the Chancellor attempted to address some of the UK’s more structural issues: labour supply constraints – by increasing childcare funding and removing disincentives for older workers by raising the maximum pension pot – and business investment – blunting the impact of super-deductibility and the increase in the corporate tax rate by announcing a full expensing of capital allowances for the next three years in an effort to incentivise business investment (estimated to cost around £30 billion over five years).
These measures summed to £22 billion in the coming financial year, accounting for a large share of the £25 billion saving the OBR forecasts for this year. The medium-term outlook remains supportive of this increased spending. The OBR raised its growth outlook for this year and next, but softened growth looking a little further ahead. Our own outlook is less rosy than the OBR’s in the immediate future and this will be a risk to the finances in future years. However, the OBR estimates that the Chancellor is on track to meet his fiscal rules – borrowing below 3% of GDP in five years’ time and debt falling as a proportion of GDP over the same timeframe. In that context, today’s Budget appears a success in allowing the Chancellor to address the economy’s most pressing needs, providing medium-term support to the growth outlook and maintaining an overall commitment to sound finances – something so lacking six months ago. Yet perhaps the Chancellor’s biggest challenge lies ahead of him. The upcoming Autumn Statement will be the most opportune to provide further ‘boosts’ to the economy before the next General Election, due in 2024. With little expectation that the finances will provide a similar result this Autumn, the Chancellor will have to be more creative to bolster his party’s lagging fortunes in the polls, while continuing to lay rest to the ghosts of the September 2022 exercise.
Spring Budget Measures – a focus on boosting participation
The Chancellor announced key measures extending energy support as expected and also provided additional measures to boost labour force participation and incentivise business investment in his “Budget for growth”. But a notable omission was any provision for public sector pay – perhaps a signal that strikes are likely to roll on to the spring on a day when six unions are staging walkouts across sectors such as healthcare, transport and education. In total, the policies announced are set to add around £20 billion a year to borrowing between 2023-24 and 2025-26, declining to around £10 billion by 2027-28.
The Treasury announced this morning that the EPG will be extended to cap the typical annual household energy bill at £2,500 until June 2023. The cap had been scheduled to rise to £3,000 from April. Notionally, the cap will now rise to £3,000 in July, but with lower wholesale gas prices, household energy costs are likely to decline well below this level as the OFGEM price cap is projected to be around £2,100 from Q3 2023. The squeeze on households is still set to be considerable with gas prices remaining high at close to double their levels at the start of 2021 and wholesale gas prices remain volatile so there is still considerable uncertainty over where the cap will land in six month's time.
Polices to boost labour force participation, which has struggled to recover following the pandemic, were also announced totalling £7 billion. The government is set to provide greater assistance for working parents providing 30 hours a week of free childcare for children between nine months and two-years old (£4 billion). Extending the support that is currently available for children above three years old. The OBR estimates that by 2026-27, this policy will allow 60,000 additional workers to enter the workforce as well as supporting the existing 1.5 million working mothers of young children to increase their hours. The childcare policy has the largest impact on increasing potential output in the budget. Changes to lifetime and annual allowance on pension contributions were announced, with the reforms expected to increase employment by 15,000 workers – reducing some of the financial disincentives to remaining in employment for those with larger pension pots. This policy was particularly targeted at older medical professionals, but it remains to be seen how far this policy can go to reversing the wider trend we have seen of older workers exiting the workforce.
With investment super-deductibility due to end at the end of this financial year, the Chancellor also introduced a temporary increase in the generosity of capital allowances for businesses (£11 billion), allowing firms to reduce their taxable profits by 100% of the cost of their investment for three years from April 2023. The OBR views that this policy will accelerate investment plans, but crucially does not judge that it will lead to a larger capital stock overall due to the temporary nature of the policy. Although the Chancellor suggested that the policy could be made permanent in future statements.
Chancellor Hunt delivered his second fiscal statement to Parliament. The Chancellor was boosted by an improved outlook for the UK economy – albeit from a bleak forecast in November – and the OBR removed its prediction of recession this year (just) and raised the overall growth outlook for the coming two years. Combined with additional boosts from lower gas prices this led to a marked improvement in the outlook for the public finances – a reduced deficit outlook and lower debt profile – and allowed the Chancellor some fiscal manoeuvre to address the economy’s most pressing issues. Chancellor Hunt has used this bonus to set out measures to improve the UK’s growth outlook. However, far from being a fiscal give-away designed to boost demand, this Budget saw a more considered targeting of some of the economy’s structural weaknesses. As such, it should go some way to improving the economy’s trend growth rate over the medium-term.
The Public Finances – an improved outlook
Overall, the borrowing profile has improved compared to November. PSNB is now expected to be £25 billion lower at £152 billion this FY (6.1% of GDP), compared to £177 billion in November. This improvement in borrowing was driven by the lower-than-expected cost of the Government’s EPG, stronger tax revenues and lower spending from local authorities. Over the full forecast horizon, borrowing is forecast to be £50 billion lower.
The performance of the finances against the government’s fiscal rules has been mixed – though the government’s overall fiscal position has undeniably improved. The fiscal mandate that states that debt (PSND) as a proportion of GDP should be falling within five years is forecast to be met, but with an even slimmer margin than before. The OBR now see just a £6.5 billion (0.2% of GDP) headroom compared to £9.2 billion prior. In the context of five years’ of forecasts, such a margin is tiny. The target that borrowing (PSNB) should be less than 3% of GDP in the same time frame is set to be met more comfortably with headroom of £39.2 billion (1.3% of GDP) – an improvement of £18.6 billion compared to the November forecast.
Yet despite the smaller margin with which the government is set to achieve its debt mandate, the government’s debt position has improved markedly. Underlying forecast improvements were largely offset by slower nominal GDP growth towards the end of the forecast profile and additional spending decisions due to come into effect in later years of the forecast. Debt is now expected to rise to 100.6% this year and peak next year at 103.1%. This is 3.6 percentage points lower than it previously expected and is forecast to decline to 97.6% at the end of the forecast horizon in 2026-27. In this context, the specifics of the fiscal mandate – to be falling in the fifth year – are more arbitrary compared to the material forecast reduction in debt over the five year-period as a whole.
Despite the announcement of a range of measures, there was only a modest boost to government spending amounting to £20 billion over the total forecast horizon with real spending little changed. Over the next two years, government spending is forecast to be lower driven by the falling cost of the EPG. The spending profile increases somewhat towards the back-end from additional spending commitments made by the government.
In real terms spending is still set to rise by 7.5% this year and -1.7% next year, however the tightening that was set to come into effect in 2024-25 had been softened. TME is now expected to decline by -1.3% in real term compared to the -2.8% drop forecast in November and continues to grow by 1.3% on average for the last three years. Tax receipts are forecast to rise by 6.0% this year and are projected to grow by 2.2% on average over subsequent years driven by an improved growth outlook and the impact of government policies announced to boost participation.
Taken together and allowing for the impact of the economic cycle, the fiscal stance is now forecast to loosen by 0.7% in this financial year, compared to an estimated loosening of 1% in November. The fiscal stance is then set to tighten more sharply by -2.3% of GDP next year and a further -2.1% in 2024-25 with further tightening of 0.2% per year seen over the remaining forecast horizon.
The economic outlook – a healthy recovery from next year
A large part of the improvement in the underlying finances comes from the forecasts of the economy – particularly the broader growth picture – and particularly in the near-term. The OBR now forecasts that the UK avoids recession. This includes a forecast of GDP contraction in Q1, but stagnation in Q2 – echoing the pattern of H2 2022. Although growth in 2022 is trivially lower than expected at 4.0% (-0.2ppt from November’s estimate), growth for this year is now forecast at just -0.2% (from -1.4% in November) and 2024 is forecast to see growth average 1.8% (up 0.5ppt), with growth forecast at a solid 2.5%, 2.1% and 1.9% in the three subsequent years. This is a solid forecast for the UK economy, close to matching the 2014-2017 expansion period of post-GFC recovery. To our minds, risks to the outlook are to the downside, with our own forecast of a slower rebound that is likely to see next year’s growth closer to 0.5%. We think a quicker rebound will be challenging in a the softer international growth environment that we expect.
The OBR’s view of underlying, potential growth underpins these forecasts. The OBR has lowered its starting point for potential growth, now believing that the drop in labour force participation reflects more structural than cyclical factors. That said, a number of forecast changes lead it to consider an overall improvement in potential growth over the forecast horizon. Namely the OBR now allows for a faster rate of inward migration to boost population growth – adding around 0.1ppt per year to potential growth. It also assumes that the measures enacted by the Chancellor today to improve labour supply are broadly effective and that these offset the 0.2ppt current lower level of labour force participation. Finally, the OBR continues to forecast a positive outlook for productivity growth – boosted in the short-run by the fall in energy prices and further out by the increase in capital expenditure. The OBR assesses UK trend growth to rise by around 1.75% towards the end of its forecast. This is higher than our own assessment of potential growth.
This improvement in supply potential, combined with the shortfall in growth expected this year, leads to an output gap in 2023 of 1.3% of GDP, which the OBR only envisages closing by 2027. This persistent output gap helps inflation to fall. Chancellor Hunt described the OBR’s forecast as seeing headline inflation fall to 2.9% before year-end, to average 6.1% this year. This is broadly in line with our pre-Budget forecast of 6.2% – although this does not account for duty freezes, nor the extension of the EPG to July, that the Chancellor stated would take 0.75ppt off headline inflation after April.
Further out, the combination of a large output gap and the OBR assumption of continually falling energy prices – both oil and gas prices – see the OBR forecast of CPI inflation fall to 0.9% in 2024 (lower than our own more cautious forecast of 2.2%), before falling to 0.1% in 2025, 0.5% in 2026 and 1.6% in 2027. Such an outlook appears inconsistent with the Bank of England (BoE) achieving its 2% inflation mandate and we accordingly expect the BoE to adjust monetary policy more vigorously than the OBR assumes. The OBR assumes Bank Rate at 4.15% this year, before falling to 3.50% in 2024 and 3.20% in 2025. Our own forecasts see Bank Rate peaking at 4.25% and being cut to 4.00% by year-end, before falling to 3.00% by end-2024. A faster easing would allow for a quicker closure of the output gap.
Our overall assessment of the OBR’s short-term forecasts is that they retain a relatively rosy bias – particularly versus our assessment of potential GDP growth. That said, we caution that the OBR has lowered its growth forecasts for later years – reflecting a relatively faster catch up with potential growth. Moreover, chillingly for households, it continues to forecast real disposable income 5.7ppt lower after this financial year and next, and forecasts living standards to be 0.4ppt lower than the pre-pandemic level at the end of its forecast horizon of 2027-28.
Gilt financing – issuance rises, but avoids setting new records
The improvement in the public finances has an impact on gilt financing. The OBR revised its central government net cash requirement (CGNCR) forecast to £115.4 billion for this year (down £20.8 billion) and £159.5b billion(down £28.6 billion) for next year, with other smaller variations in National Savings and Investments. This reduced the Debt Management Office (DMO)'s total financing to £181.4 billion this year and £246.1 billion next.
Total gilt sales had, however, been set to £169.5 billion for 2022-23 and the late reduction in borrowing requirement – combined with a surge in T-bill sales to add more than £10 billion to financing than assumed a year ago – have led to a more than £20 billion increase in the DMO’s short-term net cash account. Both factors will affect gilt sales for 2023-24: the DMO will unwind the majority (£21.3 billion) of its cash position – reducing gilt sales next year – but also looks set to see the T-bill stock grow by a much smaller £5 billion this time around. The net impact is to set expected gilt sales at £246.1 billion in 2023-24.
This downward revision of planned gilt sales next year is an important one for the record books. With gilt sales having been feared to rise towards £300 billion next year and importantly the BoE adding to gilt supply through its planned quantitative tightening process, let alone not reducing supply through quantitative easing, next year had been feared to see net, net gilt issuance rise above levels set during the GFC in 2008-09. Indeed, in headline terms that will still be the case, with an expected £246 billion in sales resulting in £169 billion in sales after allowing for gilt redemptions and BoE quantitative tightening. This compares with £126 billion in 2008-09 and £130 billion in 2011-12. However, as a proportion of GDP, while these years of issuance accounted for around 7.9% of GDP, issuance in the coming year is just 6.6% of GDP and forecast to fall to below 3% by 2026-27 (see Exhibit 2).
Market reaction – Looking elsewhere
Financial market reaction has been wild since the Chancellor’s Budget. However, in contrast to Chancellor Kwarteng’s September fiscal event, this time this has little to do with the Chancellor’s statement. Broader concerns about the banking system, this time focused away from the US banking system and on developments at Credit Suisse has resulted in sharp and volatile market moves across today’s trading session – which have made any idiosyncratic UK reaction to the Budget insignificant.
Since the Chancellor started presenting the Budget, overnight interest swap pricing on the BoE’s June Bank Rate dropped by 20 basis points (bps), to rebound by 17bps; 2-year gilt yields fell by 8bps to 3.20% before rebounding to 3.30% and 10-year gilt yields fell by 4bps to 3.25% before rebounding to 3.33%. However, this volatile reaction compared to even greater volatility in US markets, where June’s Federal Reserve pricing fell by 33bps to 4.17%, to recover half of that loss; 2-yr Treasury yields fell by 20bps and 10-year yields by 10bps to 3.39% and currently trade at just 3.41%. This reflected the more global nature of market dynamics today. In this febrile market, sterling traded 0.5% lower to the US dollar, but 0.5% higher to the euro – having made sharp gains across the day.
Financial market reaction has been wild since the Chancellor’s Budget. However, in contrast to Chancellor Kwarteng’s September fiscal event, this time this has little to do with the Chancellor’s statement. Broader concerns about the banking system, this time focused away from the US banking system and on developments at Credit Suisse has resulted in sharp and volatile market moves across today’s trading session – which have made any idiosyncratic UK reaction to the Budget insignificant.
Since the Chancellor started presenting the Budget, overnight interest swap pricing on the BoE’s June Bank Rate dropped by 20 basis points (bps), to rebound by 17bps; 2-year gilt yields fell by 8bps to 3.20% before rebounding to 3.30% and 10-year gilt yields fell by 4bps to 3.25% before rebounding to 3.33%. However, this volatile reaction compared to even greater volatility in US markets, where June’s Federal Reserve pricing fell by 33bps to 4.17%, to recover half of that loss; 2-yr Treasury yields fell by 20bps and 10-year yields by 10bps to 3.39% and currently trade at just 3.41%. This reflected the more global nature of market dynamics today. In this febrile market, sterling traded 0.5% lower to the US dollar, but 0.5% higher to the euro – having made sharp gains across the day.
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