As part of the last Spring Budget, the OBR forecast that real GDP per person will grow by an average of 1.2 per cent per year between 2016 and 2021. That’s only half the annual rate of growth the economy saw in the 50 years to 2007. The OBR revised up its forecast for this year (from 1.4 to 2 per cent for overall GDP) but now expects slower growth from later this year onwards as higher inflation squeezes demand growth. It also warned that “most outcomes” from the Brexit process “are likely to depress investment, at least temporarily”.
With growth projected to be weak, markets expect interest rates to stay low. Futures markets are pricing in a three month interbank rate of only 1 per cent even as late as 2020, implying only three quarter-point rises in base rate rate over the next three-and-a-half years. With the OBR expecting inflation to exceed two per cent between now and 2020, this points to at least three more years of negative returns on cash.
One reason for this lacklustre outlook is that Chancellor Philip Hammond announced few significant policy changes. Overall, the Budget loosened fiscal policy by only £1.7bn for 2017-18, mostly due to increased spending on social care and the NHS. That’s less than 0.1 per cent of GDP; policy changes for later years were even smaller.
And while economists welcome increased spending on education and training, these won’t raise productivity for years, if at all. Economic policy can do little to affect trend growth, simply because economies are slow to adjust to rises in potential output, even if policymakers can achieve them.
Trevellyan Ward at Faraday Research described the Budget as “a damp squib”.
Mr Hammond did announce small falls in forecast public sector net borrowing - from £165.3bn to £157.9bn between 2017-18 and 2021-22. But these changes are well within the margin of error for borrowing forecasts.
What’s more, with the primary deficit (borrowing minus interest costs) under one per cent of GDP, such borrowing is consistent with a fall in the ratio of government debt to GDP. This is because negative real yields mean that government debt will fall in real terms.
The concern for investors, therefore, should not be government borrowing, but rather the threat of continued slow growth.
