Breaking (almost) all the rules - Economics Weekly

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Breaking (almost) all the rules - Economics Weekly

Lower growth forecasts meant the Chancellor had some tough choices to make in last week’s Budget. By pressing ahead with business and personal tax cuts now he chose to postpone a big chunk of austerity until the final year of this parliament. Austerity will have to be extended unless productivity and wages stage a dramatic recovery.

Economic Analysis

21 March 2016


Weaker today, weaker tomorrow.

The Office for Budget Responsibility (OBR) substantially reduced its forecasts for UK growth this year and for each of the next four years. 2% GDP growth is now expected in 2016, down from 2.4% in the last set of assumptions back in November. But this isn’t a temporary knock. The OBR has become significantly more pessimistic about the UK’s ability to grow, as shown by its lower expectations for productivity growth. It expects the economy to be 1.3% smaller in 2020 than it previously thought, which means lower wages and lower tax revenues.


Debt rule delay.

A smaller economy means that debt as a proportion of GDP won’t have fallen in the 2015/16 fiscal year, as was targeted by the Chancellor in one of his three fiscal rules. Instead, this year is now forecast to be the high point with a net debt number 83.7% of GDP, a shade under £1.6 trillion. That debt burden puts us neck and neck with the US but fractionally below the average amongst Euro area countries. France, Spain and Italy are more indebted, Germany less so.


Headline tax rates down but offset by detailed changes.

The big measures announced were planned reductions to corporation tax (down to 17% by 2020) and rises in the income tax threshold (up to £11,500 in April 2017). ISAs got a boost, raising the allowance to £20,000 a year from April 2017 when savers under 40 will also benefit from a new “Lifetime ISA” that awards a 25% bonus on up to £4,000 of annual contributions. Smaller businesses outside Scotland will also pay less Business Rates, but the restriction on tax relief of interest payments is expected to recoup £1bn a year.


The unstoppable force.

The UK labour market clearly isn't drinking any of the Chancellor's "dangerous cocktail of risks". The employment rate stayed at a record high of 74.1% in the three months to January. There were 28,000 fewer people unemployed and average earnings growth crept up a little, with pay excluding bonuses up 2.2%y/y. All very good at face value, but average earnings adjusted for inflation are still 7.3% below where they peaked in 2008. That lack of productivity is hurting households just as much as the public finances.


Canary in the coalmine?

US retail sales grew by a healthy 3.1%y/y in February. But they were down m/m, as they had been in January. While it’s never wise to lose sleep over a couple of months’ data weakening sales are worth watching. US growth has been disappointing in the last year, yet without consumers’ spending it would have been slower still. Employment is rising briskly and wages are growing, too, so these might prove to be temporary reverses. We hope.


Underlying progress.

Headline inflation in the US remained muted in February at 1.0%y/y, down from 1.4% in January. That’s well adrift of where the Fed would like it to be. More encouragingly, core inflation, which excludes volatile items like energy and food, accelerated to 2.3%, the highest level since January 2012. That will encourage the Fed in its view that inflation is moving towards more normal levels, albeit slowly.


Low for longer.

The Fed held its main interest rate in the 0.25-0.5% range last week. While the US is generating plenty of new jobs output growth is hardly running at breakneck speed and clouds from weakening economies overseas are gathering on the horizon. Reflecting this, Fed members nudged down their forecasts of growth in 2016 and of inflation this year and next and are now signalling two rate rises this year, not the four they advertised in December.



China’s January credit tsunami receded in February. After a £372bn binge in new financing in January (mainly bank loans but also corporate bonds) February’s was a more modest £85bn. Still, if China’s new financing so far this year was an economy on its own it would be the world’s 20th largest, nestled in between Saudi Arabia and Switzerland. To say this level of credit growth is “unhealthy in the long-run” would be a significant understatement. 



China’s fiscal stimulus and credit binge has yet to arrest the decline in growth. Industrial production slowed to 5.4%y/y in the first two months of the year, continuing the decline that began over two years ago. The Chinese authorities will be hoping the recent stimulus will be enough to change economy’s fortunes in the coming months.

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