What did we learn from the second UK Budget of 2021?
The UK chancellor Rishi Sunak’s second Budget this year provided some better news on the state of the economic recovery. However, higher inflation looms due to global energy prices, and many pandemic related challenges remain.
Today’s speech focused on providing support for households and businesses, and sought to progress the government’s “levelling-up” agenda – increasing investment in local infrastructure outside of the capital.
The Office for Budgetary Responsibility (OBR) has revised up its real GDP forecast for 2021 from 4% (March forecast update) to 6.5%. But it has revised down 2022’s forecast from 7.3% to 6% - though this is largely a function of a faster recovery from the pandemic recession.
By the end of this year, the level of GDP is forecast to be about 2.5% higher than previously, but interestingly, the difference falls to just 1.3% by 2025.
Interestingly, the OBR did not update its numbers for the latest revisions and weaker monthly GDP growth figures which were recently published. You can read more about these here.
The OBR would have probably downgraded its near-term outlook slightly as a result, but overall, the growth numbers seem reasonable. The Schroders forecast has growth of 7% and 6.7% for this year and next, though these have not factored in the negative impact from the higher inflation on the horizon.
The OBR forecasts CPI inflation to average 4% in 2022, before falling to 2.6% in 2023 and eventually back to 2% by the end of the forecast. The profile published has CPI peaking at 4.4% in the second quarter of 2022, due to the expected big increase in the Ofgem energy price cap. Again, this seems to be a reasonable assumption in terms of the peak, though recent oil price rises suggest some additional upside risk.
Our note: “What does the European natural gas crisis mean for inflation?” discusses the issue in far more detail, but our latest projections suggest CPI inflation could rise to above 5.5% next year before coming down.
The fall in inflation after the gas price shock is also interesting. The OBR has inflation returning slowly to 2%, as almost every forecast it has ever published does – suggesting a stylised profile.
But our analysis suggests that a big spike up will cause a negative base effect, which could push CPI to below zero temporarily in 2023, before slowly climbing back to below 2% by the end of that year. This matters more for monetary policy, which the Bank of England will provide an update on next week. However, the OBR may see lower tax receipts, but also lower spending increases that are linked to inflation, as a result.
Higher real GDP and inflation help boost tax revenues, but also raise nominal GDP for which most financial metrics use as a base/numerator.
Public sector net borrowing is estimated to be about £51 billion lower in financial year 2021/22 – 2.4 percentage points lower in GDP terms compared to the March forecast. Borrowing will still be high at 7.9% of GDP this year, but is forecast to fall to 3.3% of GDP in 2022/23, and continuing to fall to 1.5% by 2026/27.
Public sector net debt is forecast to peak at 98.2% of GDP this financial year, then falling each year to 88% of GDP by 2026/27.
A borrowing and debt profile that is falling in coming years sets up Sunak perfectly for big giveaways ahead of the next election. By then, the government will hope that the public will have forgotten about the huge tax increases (in National Insurance and corporation tax) that were announced earlier this year, but quietly ignored in today’s speech. The tax-to-GDP ratio has been revised up further, and is now forecast to rise from 34% (2020/21) to 36.2% by 2026/27 – the highest level since 1949/50.
Instead, the chancellor decided to focus on various spending increases including real-term increases in departmental budgets. The government’s “levelling-up” agenda was formally put into action, as Sunak called for bids from regional authorities for funding being made available.
There were also increased allowances for various businesses, including a big 50% discount on business rates for hospitality and entertainment firms – some of the worst impacted by the pandemic. Extra money for schools, and additional funding for research and development will be welcomed.
There was less than expected announced for green initiatives. The cancellation of planned fuel duties increases were justified by record high prices, while the cut in air fair duties within the UK were heralded as a Brexit prize. Yet, both are a step backwards in the green agenda and will receive criticism accordingly, especially as the UK is hosting COP26 next week.
Amid a significant backlash for ending the £20 per-week additional allowance to the Universal Credit (a subsidy for low income families), the chancellor partially offset the move by reducing the taper of the allowance as pay/hours are increased. This is estimated to give back £2 billion of the £6 billion reduction in the allowance.
Another major miss by the chancellor was not cutting VAT temporarily on households’ home energy bills. We estimate that a typical household will see annual bills rise by 73% - or just over £927 - in April next year. Instead, the Exchequer will benefit from the windfall there.
Overall, the latest budget announcement had some good news on the outlook for the economy, but also highlighted some major challenges.
The chancellor skilfully offered a buffet of spending increases, but avoided talking about some big tax increases which partially offset the fiscal benefits. However, the aggregate of policies announced are mildly stimulative, and are estimated to be worth 1% of GDP in 2022/23 and another 1.7% of GDP in subsequent years.
Assuming the recovery goes as planned, the chancellor is on track to lower borrowing and debt levels, just in time for the next pre-election fiscal binge.
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