Deficit still remains a problem

Unless you’re a fan of bingo or Scotch whisky, the budget can be condensed into two main points.

Firstly, there were the big changes to the rules on savings and pensions. If you want to read about these in more depth, my colleague Ed Bowsher has written a piece looking at them.

The other big takeaway that the chancellor was keen to mention was that growth forecasts have risen. This is clearly good in itself, because it means more jobs and that incomes will go up at a faster rate than inflation.

As he pointed out, it will also have a knock-on effect on public finances. More people in work, earning more money will mean more in taxes and less on welfare spending. This means that the deficit will be smaller and debt will be lower.

However, while George Osborne may want everyone to break out the champagne, the reality is that the upgrades to growth and the public finances are very modest.

Higher growth – but only slightly

Last autumn, the Office for Budget Responsibility (OBR), which makes these forecasts, suggested that growth will be 2.4% this year and 2.2% in 2015. The new forecasts increase this year’s figures to 2.7%. Growth is also expected to be 2.3% by next year.

This is clearly an acknowledgement that things are getting better, but the upgrades aren’t huge – 0.3% in the case of this year and 0.1% in 2015. Beyond 2016 and 2017 the forecasts are unchanged. Buried deep within the footnotes, the forecast for 2018 has been cut.

Another interesting detail is that the output gap, the difference between current GDP and the GDP the economy can produce without overheating, has been cut by more than the upgrades. This suggests that the recovery is going to be much shallower than previously thought.

It also reinforces our suspicion that during the last years leading up to the crash, a lot of the excess capacity was illusory. This means that the forecasts are unlikely to improve further.

Now, it is possible that the OBR is simply being too cautious. For instance, the Bank of England (BoE) thinks that growth could be as high as 3.4%. The gap between the BoE and the OBR for 2015 is a bit smaller, but Mark Carney’s team thinks that the economy could expand by 2.7% in 2015.

However, if the OBR is being cautious, it’s not alone. Indeed, its new forecasts are actually in line with most economists, which also put growth at 2.7%.

Public finances still a problem

The revisions to the deficit and public debt are also much smaller than the coverage would imply.

The simplest measure of the gap between revenues and spending is public sector net borrowing (PSNB). However, the PSNB for 2014-15 will still be 5.5%, compared with 5.6% in the December forecast, and will not be in surplus until 2018-19. This shows that the government is still on course to miss its target.

Even the government’s preferred measure, which adjusts for the economic cycle and excludes capital spending, will still be in deficit until 2017-18 at the earliest. Public sector debt as a percentage of GDP will peak at 78.7% (down from 79.8%) in 2015-16.

As Nancy Curtin, of Close Brothers Asset Management points out: “Realistically, Osborne had to make the most of very little. Five years ago, the deficit was expected to reach half the level it is at now”.

Of course, these figures are misleading. As we’ve pointed out in our End of Britain report, all the official figures exclude the costs of the various financial interventions during the crisis – which would push our debt to well over 120% of GDP.

This highlights the Bank of England’s dilemma. If it keeps interest rates low, then there is a risk that inflation could become a problem. However, if it starts hiking rates, then interest payments rise, making the fiscal situation much worse.

We think that the Bank will take a cautious path, meaning that despite the recent measures (which you can read about here), savers are likely to carry on experiencing negative real interest rates.


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