Britain’s public finances face a black hole in three years if the economy follows the path forecast by the Bank of England, breaking chancellor Sajid Javid’s new rules to guarantee a current budget surplus.
Financial Times calculations suggest that the lower rates of sustainable economic growth forecast by the BoE would leave the chancellor with a £12bn deficit by 2022-23, instead of the £5bn surplus laid out in the Conservative’s election manifesto.
The projections, based on modelling by the Office for Budget Responsibility, would see Mr Javid facing the difficult task of having to consider tax rises and more austerity before his first Budget on 11 March to ensure the fiscal watchdog gives his new budgetary rules a pass mark.
“We can’t run an overdraft forever on our day-to-day spending,” Mr Javid said when he outlined his new fiscal rules in November, in a move that left little room for extra day-to-day spending.
The OBR’s post-Brexit economic forecasts may not be as pessimistic as the BoE’s, but the two independent bodies usually have similar outlooks. The Treasury is fully aware of the challenging landscape for the public finances.
Ministers and officials are currently working on policies to address the expected shortfall in tax revenues over the next few years alongside efforts to stimulate economic growth in the medium term.
Although Mr Javid has not set an official target, he told the FT last month that raising sluggish economic growth was his top ambition and he hoped it might reach 2.7 and 2.8 per cent. That level of growth would alleviate challenges in the public finances without having to resort to tax increases.
“I want to really turbocharge growth,” the chancellor said, although he also acknowledged: “I know it’s much easier said than done.”
According to the BoE, Mr Javid’s mission to improve the performance of the economy is likely to prove even more challenging than he had thought. It estimated that the economy would grow no more than 1.1 per cent a year if the bank stuck to its 2 per cent inflation target.
Alongside a small amount of spare capacity, the BoE forecast the economy could grow by a maximum of 3.8 per cent in total over the next three years while keeping prices under control.
It blamed the poor outlook partly on government’s desire for a loose free trade agreement with the EU. “The rise in trade barriers as the UK leave the EU is projected to weigh on productivity growth,” the BoE said.
But the BoE’s forecast of sustainable growth is far below the rate the official budgetary watchdog predicted when it last published a full forecast last March. Then, it thought 4.8 per cent growth was sustainable over the period to 2022-23.
Using OBR ready-reckoners, a 1 per cent shortfall of gross domestic product would increase the government deficit by 0.7 per cent of GDP, implying additional borrowing of £17bn in 2022-23.
Last March, before big revisions to the calculations of the deficit and public spending increases, the OBR predicted the government was set for a £37bn surplus on the current Budget in 2022-23.
The OBR and Treasury declined to comment on the FT’s calculations.
James Smith, research director of the Resolution Foundation, said the BoE’s downgrade of the potential growth rate was justified because elements of Britain’s productivity performance had not been this weak since the Victorian era, which had serious implications. “It creates a tough outlook for living standards and the public finances,” he said.
With the government finances now looking tight, Mr Javid has written to other ministers seeking suggestions for 5 per cent savings from their budgets so the government can prioritise public spending in the autumn spending review.
Ahead of the Budget, officials are also considering possible tax rises outside those areas where the government has pledged no increases or whether to slow the overall growth rate of public spending.
The government’s new fiscal rule is to balance the current budget in the third year of any forecast.
The chancellor’s strong preference is to avoid raising taxes and use £100bn of capital spending firepower to improve the underlying performance of the economy.
Source: Economy - ft.com
