4th time around - Economics weekly


4th time around - Economics weekly

George Osborne reaffirmed his commitment to Plan A in the Budget last week.

Economic Analysis

25 March 2013

Despite an eye-catching proposal to boost the housing market, and a promise of lower corporate taxes, this was yet another fiscally neutral set of policy changes. As for the economic outlook, the UK’s fiscal watchdog expects weaker growth and higher borrowing. Meanwhile, crisis-hit Cyprus became the fourth country to receive a bail-out.

"Today, I'm going to level with people".

Following these words, the Chancellor delivered his 2013 Budget. George Osborne presented a forecast for the economy that included higher borrowing and much higher debt than previously anticipated. Net debt relative to the size of the economy is now expected to peak at over 85% in 2016/17 and an extra £56bn will be borrowed over the next five years.

However, the Office for Budget Responsibility (OBR) still thinks there is a better than 50% chance of the Chancellor hitting his fiscal mandate of balancing the (business cycle adjusted) budget in five years time.

OBR slashes 2013 growth forecast but thinks the damage is largely temporary.

In the three months since December's Autumn Statement the OBR has halved its forecast for 2013 GDP growth. It now expects the UK to grow by just 0.6% this year, down from 1.2% in December. But the fiscal watchdog did at least make the pill a bit easier to swallow: it only reduced its estimate of "potential output" by a little over 0.1%. This is a technical way of saying it expects the UK economy to recover the ground it has lost someday, rather than it being gone forever.

Big housing market push.

Among the policy changes offered, a new guarantee scheme for mortgage lending grabbed most headlines. It will enable those without a 20% deposit to take out a mortgage and buy a house. This is a big programme by any measure. The scheme has the potential to back £130bn worth of lending, which is worth more than 10% of outstanding mortgage debt.

Chancellor announces a new Bank of England mandate.

Not only will the Bank have a new Governor we will also have an amended mandate for monetary policy to allow “forward guidance”. At present, the Bank tells us each month what interest rates will be for the next few weeks, but it will now be given scope to behave more like the US Federal Reserve.

The Fed currently says it will keep rates low as long as US unemployment is above 6.5% and inflation is under control. The idea is that this forward guidance will convince people and businesses that interest rates will stay low for a long time, giving them incentives to borrow and spend.

Inflation and employment up, despite a shrinking UK economy.

CPI inflation edged up 0.1% to 2.8%y/y in February as higher utility and petrol bills pushed up the cost of living. Meanwhile, 131k jobs were added to the economy between November and January, despite a 0.3% contraction in GDP in Q4. But once again, wages failed to keep up with the rate of inflation, rising only 1.2% on a year earlier. The squeeze on household budgets continues.

A deal for Cyprus, as the Eurozone crisis rumbles on.

Details are emerging of a new bailout deal for Cyprus. The country’s two biggest banks will be restructured to raise the funds needed to secure a loan from the “Troika”. Depositors with less than €100,000 in those banks will be protected, it seems, but any amounts over and above that figure could potentially be wiped out. A solution where “small” depositors don’t lose out should be better for stability in the Eurozone’s banking system, but how much damage has already been done?

The Eurozone’s contraction gathers pace, but US and China more encouraging.

The Purchasing Managers’ Index (PMI) for the Eurozone continues to drop at an alarming pace. The composite index for manufacturing and services hit 46.5 in March from an already-depressed 47.9 in February (anything below 50 signals contraction). Weakness is spread across the Eurozone but France was the most disappointing, with output contracting at its fastest rate since March 2009.

This was the so-called “flash” estimate of the survey; the final version could be even worse, as events in Cyprus hit sentiment. More encouragingly, the good news continues to come from the US, where manufacturers have clearly gained momentum this year. The flash reading of China's manufacturing PMI rose slightly more than expected, reversing most of February's decline. All told, the Chinese economy appears to be growing at a slightly quicker pace than in Q4.

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