Budget forecasts: 5 things to look out for

The Autumn Budget will take place on 22 November 2017. The Office for Budget Responsibility (OBR)’s official forecasts for the economy and public finances – used in the Budget – will be published on the same day. Here we highlight five things to look out for in their forecasts.

1. Productivity assumption

Few, if any, economists would disagree that productivity – as measured by output per worker – is essential for driving long-term economic growth and increasing living standards. Historically UK productivity had increased by around 2% per year, but since the 2008-2009 recession it has stagnated. Productivity today is only a little higher than it was almost a decade earlier.

In previous forecasts the OBR assumed that productivity growth would return to its long-run historical average, but this hasn’t happened and there are now fewer reasons to expect it to. Therefore, the OBR has said that they anticipate ‘significantly reducing’ their assumption for productivity growth in their November 2017 forecasts.

This isn’t a trivial matter for the Chancellor. We’ve already discussed how productivity growth is essential for long-term economic growth, so we can expect reduced productivity to result in lower OBR forecasts of economic growth. Lower economic growth can then be expected to lower tax revenues and increase the Government’s budget deficit. The impact on the deficit depends on the extent to which the OBR lowers its productivity growth assumption.

The bigger the fall in assumed productivity growth, the greater the impact on receipts and consequently borrowing.

2. How much ‘headroom’ will be left under the 2020/21 deficit target?

The spending and tax decisions taken by the Chancellor in the Budget are constrained by his targets for the public finances. The Chancellor’s target for the deficit applies to 2020/21: in this year, the underlying budget deficit – adjusted for the ups and downs of the economy – must be less than 2% of GDP.

In March 2017, the OBR judged that the Government was on course to meet its deficit target ‘with a margin of 1.1 per cent of GDP’: a headroom of around £26 billion. The developments discussed in this post impact on how far this headroom will decrease or increase, before the Chancellor’s policy announcements are factored in.

While each development discussed here should have an impact, it’s fair to say that a significant downgrade in productivity could substantially eat into the headroom, outweighing the other potential improvements.

Back in November 2016, the OBR estimated that if they assumed productivity grows at 0.8% per year, rather than increasing gradually up to 2.0% per year by 2020, it would increase their borrowing forecast by around £30 billion in 2020/21. That isn’t to say that the OBR will make precisely this change to its productivity assumption, but it has said that it anticipates a significant reduction.

3. How far will the OBR reflect recent improvements in the deficit to their forecast?

Since the OBR’s last forecast in March 2017, the Office of National Statistics (ONS) has published outturn data for the deficit in 2016/17 and the first six months of 2017/18. The data suggest that there’s been an underlying improvement in the public finances.

Following revisions to the data, the ONS now believes that the deficit in 2016/17 was around £6 billion lower than its first published estimate suggested and the OBR had forecast in March 2017.

Early estimates for the first half of 2017/18 also indicate that the OBR may need to reduce its forecast for the deficit in 2017/18. The Institute for Fiscal Studies – an economics think tank – suggest that the tax and spending data behind these improvements point to a reduction in the deficit of around £11 billion per year.

4. The ONS have moved English housing associations out of the public sector – how much will this reduce borrowing?

On 16 November 2017, the ONS reclassified English housing associations as private sector organisations for the purpose of its economic statistics. The ONS had previously considered the social housing providers as part of the public sector. This meant that their borrowing and debt impacted on the deficit and government debt. In 2016/17, English housing associations added £3.7 billion to the deficit and over £60 billion to government debt.

The reason that the ONS considered English housing associations to be part of the public sector, was the level of control the public sector had over them. The Government has now brought through legislation that reduces the public sector’s control over English housing associations, which has led to the ONS moving them back to the private sector.

The OBR will reflect this change in their November 2017 forecast; the FT suggests it will lower borrowing by around £5 billion per year.

5. Interest rates and the impact on government debt interest payments

Ordinarily the Bank of England’s decision to increase its interest rate – the Bank rate – in November 2017 would have indirectly and gradually impacted on government debt interest payments. However, the Bank of England currently holds significant amounts of government debt as part of its quantitative easing programme, which aims to stimulate the economy. The cost to the public finances of holding this debt is the Bank rate.

The increase in the Bank rate therefore immediately impacts on the debt interest paid on the Bank of England’s holdings of government debt. The increase in the Bank rate could add in the region of £1.5 billion to spending in 2018/19. The cost is likely to be lower in the later years of the forecast as expectations about future interest rates have changed to a smaller extent since the last forecast – it is these market expectations that feed into the OBR’s forecast for debt interest.

Further information

The Library’s Autumn Budget 2017: Background briefing discusses the current economic situation and public finances. In the briefing, we also take a look at some policy issues that may come up in the Budget, including public sector pay and Universal Credit. We also discuss the ubiquitous issue of Brexit: specifically, how the OBR have accounted Brexit in their forecasts and how much the Government has allocated to departments to prepare for it.

Picture credit: HM Treasury Building, by Ihongchou’s photographAttribution-NonCommercial-NoDerivs 2.0 Generic (CC BY-NC-ND 2.0)