The Government’s relatively buoyant view of the UK economy, combined with the continuing upward pressure on inflation from food and oil prices, means that, even by the end of this year, inflation, as measured by the CPI, remains above-target, at 2.5% in the Treasury’s view. The Chancellor doesn’t forecast interest rates in his Budget but, if he is right, this particular combination of relatively comfortable growth rates plus above target growth in inflation through the year would suggest that base rates will not fall as far or as fast as many commentators now think. Indeed on this basis, the trough in the base rate cycle may not be far off. The Monetary Policy Committee will be loath to cut rates in a situation where inflationary expectations stay as high as the Treasury’s forecasts suggest.
The Government’s growth forecasts
Source: HM Treasury Budget Report 2008
If base rates do stay around the current level (rather than fall as many expect to 4.5% by year-end), they would tend to strengthen sterling and make life more difficult for exporters. Yet the Treasury has a relatively upbeat view of exports (at a time when the balance of payments deficit is growing). Interest rates of 5% or more would also dampen the consumer sector by keeping debt servicing costs high and would ensure that the housing market remained weak for the foreseeable future.
Even under his own optimistic scenario, the Chancellor was forced to present a much weaker fiscal position and is sailing close to the wind as far as his predecessor’s fiscal rules are concerned. In his Pre-Budget report last October, the budget deficit for 2008-09 was forecast at £4 billion. It is now expected to be £10 billion. For 2009-10 a surplus of £3 billion becomes a deficit of £4 billion with the return to surplus now being delayed until 2010-11 and the likelihood increased that the Golden Rule will be broken this cycle.
Similarly net borrowing this financial year, at £43 billion, is £7 billion higher than forecast in October. In 2009-10, at £38 billion, it is also £7 billion higher, which mean that net debt as a percentage of GDP comes within 0.2 percentage points of breaking the sustainable debt rule in 2010-11. Mr Darling must be hoping that the economy behaves as the Treasury believes it will rather than as most independent economists do. If not, he will see both fiscal rules shattered. This does not mean the economy will falter but it will undermine the government’s claim to ‘prudence’.
The revisions to his fiscal forecasts also showed how bare the Government’s cupboard is in terms of supporting any monetary policy loosening to revive a flagging economy. In fact, by 2010-11, the Budget projects almost £2 billion more will have been taken out of the economy rather than put back. The Budget therefore tightens rather than loosens fiscal policy. Given the closeness of his forecasts to the fiscal constraints introduced by Gordon Brown he simply had no room for manoeuvre and very few choices.
The public finances
Source: HM Treasury Budget Report 2008
The major revisions to personal and corporate taxation announced last year will take effect from April this year. The basic rate of income tax will fall to 20% but will be offset by the abolition of the 10% rate. On the corporate side, mainstream corporation tax is reduced to 28% (from 30%) while the small firms’ rate increases from 20% to 21%. As promised last year, there will be a flat rate 18% for capital gains tax, although concessions were made in the form of entrepreneurs’ relief. There were other gestures in the direction of small businesses but little of substance (reminiscent of Mr Brown’s tinkering).
In terms of the political cycle this was not a year when heroics were needed, and in terms of the economic cycle he had far less freedom to manoeuvre than he wanted.
Chief Economist, HSBC Bank plc
Editorial courtesy of the Daily Telegraph Business Club