Newton’s Hensman: UK in danger of robbing Peter to pay Paul

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Following chancellor George Osborne’s Autumn Statement, Peter Hensman, global strategist at Newton, said the Office for Budget Responsibility’s (OBR)1 forecasts for growth have consistently been too optimistic since the crisis. Tasked by the coalition to give independent forecasts, the OBR has now revised its longer-term growth estimates down.

The OBR’s long-run estimate for GDP growth used to be 2.8% and now it is 2.25%, acknowledging some of the structural headwinds to UK growth. There is still an implicit assumption in the OBR forecasts that aggressive monetary policy works in creating sustainable growth, which we would question.

There is danger in paying too much heed to its forecasts, which tend to be formed by extrapolating trends, just because quantitative easing has dragged growth from the future into the present, it does not mean the upturn will continue.

Last year the OBR assumed the pick-up in housing activity would be sustained with more housing transactions and a continued growth in house prices. In reality, as prices have gone up transactions have come down because people cannot afford them. This year because we have seen a strong pick-up in job growth the OBR has predicted this will continue. That may happen but equally it may not. Just because something has been going well it does not mean that will always be the case.

GDP numbers only tell us the rate of growth and not what is happening structurally within the economy. There is no denying that if you throw enough cheap credit at people and encourage them to spend it you can give the appearance of an economy accelerating. This is the model the UK had pre-crisis and it is reverting to using the same policies now, which is why we would question whether we have a sustained pick-up in activity or merely a sugar rush.

Osborne said in his statement the government expects to borrow more than £91bn this fiscal year, which is greater than the amount forecast in the Budget earlier this year but down from £97.5bn last year. Meanwhile, the deficit is projected to fall to £75.9bn next year, £40.9bn the year after and £14.5bn in 2017-18. In fiscal year 2019-20 Osborne estimated Britain to have a surplus of £23bn.

However, a significant factor in the projections for deficit reduction over the next five years was continued low interest costs and a new assumption that the UK Gilts acquired by the Bank of England under its quantitative easing programme would not be sold during the forecast period. Neither of these factors represents a vote of confidence in the outlook.

If  the government was paying market interest rates the deficit numbers would not be set to improve to the extent predicted, but since interest rates are currently 0%, as they have been for five years, this has made a big saving over time. Although the Coalition has helped to improve government finances since the crisis, considerable work still remains and even the gradual repair projected over the next 5 years is vulnerable to a less robust growth outlook than the OBR expects.

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