Few surprises to come from the Budget
April 21st, 2009
The UK budget has been well advertised in advance. Gone are the days of budget secrecy followed by the drama of the Chancellor’s presentation in the Commons. We receive some of the Budget in the Autumn Pre Budget Report. Now in the week before the budget, the jobs package, the housing package, the green cars initiative, the extra £10 billion of spending cuts and the other main runners for inclusion are briefed to the press.
There may be the odd surprise tomorrow, but it is unlikely to be anything of a magnitude that will have much impact on the economic outcome. A £1 billion housing market package is hardly going to be decisive after all the billions already tipped into housing finance through the public sector programme and through the bail-outs of the mortgage banks. A few billion here and there to help jobs, green growth and the like are not going to have much impact. This is a £1,500 billion economy so the odd billion is small.
The economy’s progress will be determined by three things. The first, the large cuts in interest rates announced in recent months, points to economic recovery by 2010. This will be reinforced by printing money, or underfunding the government’s spending. The second, the poor state of the banks, will hold back the recovery as it did in 1990s Japan. The more the government subsidise them to delay sorting out the problems, the longer it will take to have a strong recovery. The third, the state of the public finances might not give the boost the government imagines. The budget needs to persuade the markets that there is a way out of the very large deficits the Chancellor will have at last to recognise. He needs to convince us that they can be financed in the short-term at sensible interest rates, and will be controlled in the medium-term by some combination of lower spending and more tax revenue. If he cannot, then we face higher longer-term rates of interest early in the cycle. Quantitative easing is not having much impact on longer-term rates, and cannot continue indefinitely.
The Chancellor will probably adopt his predecessor’s tactic of giving some of the following years’ budgets at the same time as 2009-10’s. We will probably hear plans to rein in wasteful spending more in later years, and plans to increase taxes more after April 2010. Given the likelihood of an election in May 2010 none of this will cut much ice.
The Treasury will need to produce some more credible forecasts of economic output for both 2009 and 2010. We should expect them to say there will be slow growth in 2010 after a bigger drop in 2009 than they have so far admitted. The size of this drop will have a marked impact on the level of the public deficit, as the numbers are very sensitive to levels of output. If they admit to say a near 4% GNP decline in 2009, that will boost benefit spending and cut tax revenues substantially, driving the borrowing requirement higher. They are likely to go for a more modest forecast of GNP decline, hoping that the action taken to date will cushion the fall.
The reality is slower growth for some years to come, once recovery does belatedly get underway. Four of the turbo chargers on the UK economy in the decade up to 2007 may no longer apply. The rapid growth of credit and the fast growth of property prices are unlikely to be repeated soon. The high level of inward migration is likely to reduce as a result of fewer jobs on offer and tougher immigration policies restricting numbers. The lead sector, banking and financial services, will not be able to sustain its own heady performance of recent years. Public spending will need to be restricted, after years of rapid growth.
On the positive side there can be more growth in exports and import substitution on the back of a weaker pound and better control of wages and salaries. The UK needs to save, invest and export more, and spend, borrow and import less.
The UK equity market will now face a UK headwind as a result of the slower domestic growth, but will otherwise respond to the global picture given the high proportion of UK larger companies that have substantial overseas and foreign currency exposure. We continue to favour faster-growing economies for our investments in shares and other real assets. We do not think this UK budget can produce a miracle cure for what is a deep-rooted set of domestic problems.
