United Kingdom: Autumn budget sets out more expansionary fiscal stance
On 29 October, Chancellor Philip Hammond presented the autumn budget, which marked a notable loosening of the fiscal stance due to tax cuts and spending rises. However, thanks to an underlying improvement in the public finances since March this year, the OBR—the official independent fiscal watchdog—revised down its near-term fiscal deficit forecasts, and still sees the public debt-to-GDP ratio declining over the forecast horizon.
The budget raises the minimum and higher-income tax thresholds, increases the minimum wage by roughly 5%, and boosts spending on welfare and health—among other more minor fiscal tweaks. This should support domestic demand and have a positive impact on GDP growth in 2019. According to analysts at Berenberg: “Following the tax cuts announced in the 2018 Budget we have raised our calls [for GDP growth] by 0.2ppt in 2019 and 0.1ppt in 2020.” Economists at Nomura take a similar view: “The measures announced in today’s budget are worth around 0.7% of GDP per year between 2019-20 and 2021-22, rising to over 1% of GDP by the end of the forecast horizon. This is, therefore, the biggest fiscal loosening since the recession following the financial crisis.” The OBR itself revised up its 2019 growth forecast from 1.3% in March to 1.6%.
Despite the spending splurge, the underlying improvement in the public finances in recent months—driven by stronger tax receipts and lower public spending on welfare and debt interest payments than predicted—led the OBR to slightly revise down public borrowing forecasts over the coming years. Consequently, the budget deficit is seen at 1.4% of GDP in 2019–20, compared to the 1.6% forecast in March. In the long-term, the budget deficit forecast is largely unchanged. As such, markets are unlikely to become concerned over the administration’s commitment to fiscal prudence, with economists at Nomura arguing that the budget “shouldn’t cause a major reaction”. Adrian Paul, an economist at Goldman Sachs, succinctly sums up the situation: “Today’s Budget constitutes a gift spent. In essence, the OBR has substantially upgraded the underlying outlook for the public finances. The Chancellor has used almost all of that underlying improvement to increase public spending.”
Regarding monetary policy, the more expansionary budget could encourage the Bank of England to accelerate its tightening cycle. However, the evolution of Brexit negotiations is a key downside risk: A no-deal Brexit would quickly render current growth and fiscal forecasts obsolete, thus necessitating an abrupt change in fiscal and monetary policy. As summarized by James Smith, developed markets economist at ING: “Hammond confirmed that he could implement an emergency budget in the spring if needed to provide offsetting support, and we also suspect this would also be quickly followed with a Bank of England rate cut/additional QE.”