The big economic news yesterday wasn’t being made in Westminster, but in the Middle East and in the market reactions over in the City of London. Gas prices rose by more than 20% yesterday and are up almost 80% compared to Friday. The stock market fell almost 3%. The cost of borrowing rose sharply. Maybe these changes will be short-lived; there are many days with large market moves that we quickly forget.
But if war in the Middle East drags on that will be unambiguously bad news for all of us, including for the Chancellor. On the economic front, higher oil and gas prices and more economic uncertainty would drag on economic growth. Disposable incomes would fall as inflation rises. Higher inflation would likely mean higher interest rates. We should all hope that we are not facing a protracted conflict.
If we do see a prolonged period of higher energy prices, there will undoubtedly be calls for the government to step in to provide financial support to households; opposition parties were already calling for cuts to fuel duty in the House of Commons yesterday. We have become accustomed in recent times to governments propping up household incomes when bad shocks come along. While there can obviously be benefits to this, protecting household incomes in this way is not costless. This kind of government support is a key reason that debt has been rising in recent years. And, partly because bad shocks keep coming along, and partly because we are aiming only to stabilise debt in the better times, debt keeps rising over time. That can’t go on for ever.
Big challenges ahead
Stepping back from the new and uncertain challenges raised by events in the Middle East, we should remember the difficult public finances back drop and the challenges ahead. The big story from the Spring Forecast is the forecast itself – not how the forecasts have changed since November.
As an aside, it’s worth noting that it’s not that surprising that the forecasts haven’t changed that much. The last set were published just three months ago. It would be more useful if the forecasts were more evenly spaced – with the second forecast, say, six months on from the Budget. Or, perhaps it would make more sense to have an updated forecast published three months ahead of a policymaking Budget, to tee up the big questions and issues, rather than one 3 months after.
But, timing issues aside, the story of the forecast, while not new, deserves another day in the news.
The economy and household incomes are set to grow across the forecast. And the Chancellor was keen to highlight that growth in incomes is forecast to be stronger than in the last parliament. But that is a low bar indeed, given that we saw the worst parliament for growth in household incomes on record. The forecasts look similar to the growth seen in the 2010-2015 parliament, which is still falls far short of the much stronger economic and income growth seen in the decades before the financial crisis.
Turning to the public finances, it is worth repeating what we already knew: Debt is high. Borrowing is high. The cost of borrowing is high. The government does have a plan to reduce borrowing sharply over the rest of this parliament but that is predicated on them being able to deliver taxes rises and restrained spending growth in the run up to the general election. Some scepticism about that is warranted. As the OBR highlighted in the opening paragraph of their Economic and Fiscal Outlook, recent governments have all had plans to cut borrowing but they rarely deliver.
To put some numbers on this, over the eleven spring forecasts between 2010 and 2020, the average plan was to reduce government borrowing by 3.7 per cent of GDP by the fourth year of the forecast. The average reduction actually achieved was just 0.3 per cent of GDP. This partly reflects those nasty shocks that keep coming along. But it also tells us that talk is cheap and that it is much easier to say that borrowing will be cut than to actually cut it. The number of U-turns we’ve already seen from this government does not inspire confidence. These include a couple of small policy reversals that were announced between the last Budget and the Spring Forecast. Put those alongside a more significant spending top up for special education needs and disabilities, and policy changes since November have added £6 billion to the borrowing forecast for 2029-30.
There are always risks to economic forecasts and the new OBR forecasts highlighted three that could materialise in the forecasts that will underlie the Budget in the autumn.
One risk relates to rising unemployment, which is a potential cause for concern. The OBR’s view is that unemployment will rise this year and then start falling back in 2027 – so the uptick would be only a temporary blip. That view is not universally held. If instead we’re seeing a more structural change in the labour market, and the UK should now expect higher levels of unemployment as standard, the OBR’s numbers could end up looking too optimistic. The data here continues to be a bit of a nightmare, but this is something to watch closely.
A second risk relates to the fall in net migration. The OBR have revised down their forecast for net migration on the basis of new estimates suggesting more people are leaving the UK than was previously thought. They didn’t change their forecast for immigration into the UK. But there’s at least a good chance that this too will be revised down in the autumn. At least over the short term, we’d expect fewer migrants to mean less tax revenue and more borrowing.
A third risk relates to what’s actually been one of the better pieces of news for the public finances. The stock market has had a good run recently, rising by 8% between the last forecast and this one, and pushing up forecast tax revenues by a chunky £9 billion in 2030. Much of this comes from higher capital gains tax revenues. But as we’ve seen in recent days, these stock market gains can be ephemeral. With rising shares of tax revenues coming from taxing capital gains, this leaves us more exposed to the volatility of asset prices.
On top of these risks, there are clear pressures on public spending. Perhaps top of the list of pressures are calls to increase defence spending, which were growing even before the Middle East conflict. The scale of potential ambition here is important. The UK currently spends around 2.4% of national income on defence. Meeting the NATO commitment to move that to 3.5% would cost around £35 billion per year in today’s terms. That’s the equivalent of what we current spend on the Ministry of Justice and Home Office combined. Funding it through higher taxes would mean, for example, 3 – 3.5 ppt on the main rate of VAT. The takeaway is that we should not expect the government to be able to meaningfully increase what we spend on Defence – if that’s what it decides it wants to do – without significantly cutting other government programmes or raising taxes.
The Chancellor said nothing about future spending challenges in the Spring Forecast, but we should expect them to be central at the autumn Budget. At that point, we expect the government to set the envelope for the 2027 Spending Review. At the last budget, the Chancellor cut back plans for public service spending in 2028, with reference to yet more efficiency savings. That’s already been topped up with additional spending for children with special education needs and disabilities. The government will have to decide whether they do in fact think they have the ‘right plan’ or whether they want to raise more taxes so that they can top up spending plans further.
What next?
Where does this all leave us? In many ways we are in a holding pattern. The Chancellor apparently has new ideas for how to increase growth, but we will have to wait another few weeks to hear about those in her second Mais lecture. We’ll be paying close attention. This stuff matters. There’s far more to growth policy than tax and spend.
Then, we’ll be looking ahead to the numerous big decisions that will need to be made in the autumn – though events in the Middle East could force the government’s hand sooner. Decisions on spending will be particularly important, and could shape the second half of the parliament.
Finally, I want to reiterate what we said yesterday. The Chancellor really does deserve credit for avoiding the temptation to turn the Spring Forecast into a fiscal event and make new policy announcements yesterday. One fiscal event per year is enough. Had she chosen to use the modest improvement in the borrowing outlook as cover for a round of pre-local election giveaways, I’d now be telling you how unwise that was. Instead, it was as close to a non-event as these things go. It gives an opportunity to step back and think about the big picture. And now my colleagues will do just that.
