In delivering his first Budget as Chancellor of the Exchequer, Rishi Sunak faced the enormous challenge of both delivering on his party’s pre-election promise to end austerity and “level-up” regional growth, but also to provide support in response to the expected negative impact from the coronavirus outbreak.
Earlier in the morning, the Bank of England delivered an unscheduled emergency cut to its policy interest rate: from 0.75% to 0.25%, along with easing conditions for the banking system. This level of co-ordination has not been seen since the global financial crisis, highlighting the level of severity.
The coronavirus response
Starting with the emergency response, Sunak announced a range of measures worth around £30 billion or 1.4% of GDP. This includes £5 billion of emergency funds for the National Health Service, an expansion of the statutory sick pay system to start payments earlier, and also to cover some self-employed workers. Small firms are receiving help by being able to claim a refund of the cost of sick pay for the first two weeks of absenteeism, in addition to having access to “business interruption” loans.
Economic forecasts are made far more uncertain because of the level of disruption that’s yet to unfold. The Office for Budget Responsibility (OBR) was forced to close the forecast towards the end of February, and so has not been able to account for the recent escalation, or the government’s emergency package. This suggests that there is considerable downside risk to the numbers published.
Downgrade to growth forecasts
Compared to its last update in 2019, the OBR has downgraded its forecast for real GDP growth from 1.5% to 1.1% for 2020 (slowing from 1.4% in 2019). Growth is then forecast to rebound to 1.8% in 2021 (revised up from 1.6%), before slowing to 1.5% in 2022 and 1.3% in 2023. The outer two years were also downgraded, driven by a re-assessment of the UK’s long-term productivity forecast. This is partly caused by continued weaker productivity growth, but also partly in reaction to assumptions made around the UK’s future relationship with the EU following Brexit.
The long-term downgrade highlights the OBR’s view that the UK will have limited capacity going forward. Indeed, its current estimate of a positive output gap (a measure of slack in the economy) suggests that the economy is already running hot and generating domestic inflation. This is an important point as in attempting to deliver on pre-election promises to stimulate the economy, the chancellor may find that he generates more inflation than growth in real terms.
Beyond the near-term stimulus measures, the chancellor announced that he would lift the threshold for National Insurance Contributions from £8,632 to £9,500 – removing an estimated half a million people from its scope, and saving up to £85 a year for those earning above the new threshold. Ideally, he would have scrapped the antiquated and complex tax and rolled it into income tax.
Following Brexit, the UK will be free to change its VAT schedule on various goods, including sanitary products. Sunak made good on the promise by announcing the scrapping of VAT on a number of products from the start of next year, though this would have to be delayed if the Brexit transition period is extended.
For the sin taxes, fuel duty will continue to be frozen, despite heavy lobbying from climate change groups. Duties on spirits, beer, cider and wine also remain frozen, but duty on tobacco will rise at 2% above the RPI inflation rate.
For businesses, there was disappointment as Sunak confirmed that the planned cut in corporation tax from 19% to 17% has been scrapped. However, business rates have been abolished for retailers, leisure and hospitality sectors with a rateable value of below £51,000.
There were also a number of green measures, including the introduction of plastic packaging tax from 2022, and duties on imports that are made up of less than 30% recyclable material. Given the recent flooding experienced, additional funds had to be included for building better flood defences.
Additional funds were also announced to repair roads, along with major upgrades to rail, broadband and the construction of housing. However, international readers will be interested to learn that a new 2% additional stamp duty charge will be levied for foreign buyers of UK properties will be introduced from April 2021.
Impact on public debt
Overall, the cost of the various measures announced will clearly cause public borrowing to rise. The OBR forecasts public sector net borrowing to rise from £38.4 billion in financial year 2018/19 to £47.4 billion this financial year, before peaking at £66.4 billion in 2021/22. As a share of GDP, borrowing rises from 1.8% in 2018/19 to a peak of 2.8% in 2021/22, before falling back to 2.2% in 2024/25. The increase annual borrowing includes an increase in public investment, which rises from 2% to 3% of GDP.
Despite the additional borrowing, public sector net debt is forecast to fall from 80.6% of GDP in 2018/19 to an average of just over 75% of GDP throughout the latter part of the forecast horizon.
Three risks to temper optimism
Overall, the chancellor delivered a bigger package of measures than anticipated, especially as he is due to deliver another Budget this autumn. Emergency funding to help cope with the coronavirus is certainly welcomed, while efforts to boost public investment is badly needed and long overdue. However, there are three major risks that should prompt optimism to be tempered.
First, the impact of the coronavirus could be far larger and widespread that expected at present and included in the OBR’s forecast. This means that the public finances could be in a less healthy position, jeopardising many of the investment plans announced today.
Second, the lack of spare capacity remaining in the economy has worsened the trade-off between growth and inflation. The sharp rise in public investment and spending could generate more inflation than growth, which could prompt the Bank of England to tighten policy.
Finally, Brexit risk remains. The OBR has assumed a trade deal will be completed by the end of this year, but there is still a significant risk that talks breakdown, causing trade chaos and big tariffs to be applied to at least the UK’s exports to the EU. At least the government is the master of its own fate for this risk.
By Azad Zangana, Senior European Economist and Strategist at Schroders