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As the economy slows we see incomes and subsequent household spend flattened by inflation stalling growth in the economy. It all seems somewhat counter intuitive considering reported strength of jobs growth. But his if it is true, and I doubt it, has been an effect of weak productivity. Persistent productivity shortfalls can artificially receive an aggregate boost from but leads to noncompetitive per-capita output, not boding well for the UK’s growth prospects in a post BREXIT world.
The ONS revised public borrowing significantly lower in 2016-17, in contrast with its previous forecast last March. The deficit continued to fall in the first half of 2017-18 and borrowing was accordingly revised down by £8.4 billion to £49.9 billion for the full year, only slightly up on 2016-17 because of a timing effects boost in receipts last year. Real GDP forecast however has been slashed. Expectations for growth going forward are now expected to be average.
1.4 per cent a year over the next five years, slowing a little over the next two (as public
spending cuts and Brexit-related uncertainty weigh on the economy) and picking up
modestly thereafter as productivity growth quickens. The main reason for lowering our GDP
forecast since March is a significant downward revision to potential productivity growth,
reflecting a reassessment of the post-crisis weakness and the hypotheses to explain it.
1.4 The combined effects of a better fiscal position now, but weaker prospects looking forward,
have led us to revise up our forecast for the budget deficit by increasing amounts over the
next five years, even before accounting for the Budget measures. In the Government’s fiscal
target year of 2020-21, our underlying upward forecast revision of £13.7 billion absorbed
roughly half the headroom against the ‘fiscal mandate’ shown in our March forecast.
1.5 Faced with a weaker outlook for the economy and the public finances, and growing
pressures on public services following years of cuts, the Government has chosen to deliver a
significant near-term fiscal giveaway. This adds £2.7 billion to borrowing next year and a
larger £9.2 billion (0.4 per cent of GDP) in 2019-20. The package includes net tax cuts (to
fuel duty, inevitably, and stamp duty for first-time buyers), a significant easing in previously
planned cuts to current departmental spending and a boost to capital spending. Together
they provide a modest boost to GDP growth in the years we expected it to be weakest.
Consistent with the pattern of many past fiscal events, the policy easing is then scaled back
in future years, with a small fiscal tightening ultimately pencilled in for 2022-23 in the form
of further cuts in public services spending as a share of GDP.Despite the deterioration in our underlying forecast, the tax and spending giveaway, and
extra lending through Help to Buy, the Government has ensured that net debt still falls
fractionally as a share of GDP in 2018-19 and by more beyond. It has achieved this largely
by announcing fresh sales of RBS shares and by passing regulations that ease local and
central government control over housing associations in England. In response, the Office for
National Statistics has announced that it will treat them as private sector entities from the
point at which the regulations take effect. This has reduced our borrowing forecast by
around £3¾ billion a year and reduced our debt forecast by between £67 and £81 billion.
But housing associations’ role as providers of a public service means that this accounting
change has no material effect on the underlying health and riskiness of the public finances –
if the sector faced serious financial difficulties in the future, it seems equally likely that the
Government of the day would choose to stand behind it whatever its statistical classification.
1.7 Chart 1.1 shows how the different factors have affected our borrowing forecast since March.
Our underlying forecast changes and the Government’s fiscal loosening generally push the
deficit higher while statistical changes have reduced it more modestly. Absent Budget
measures, borrowing would have troughed in 2019-20 and fluctuated thereafter. Once
Government decisions are factored in, the deficit declines more smoothly over time.
On this basis, our central forecast implies that the Government’s fiscal mandate – for
cyclically adjusted borrowing to lie below 2 per cent of GDP in 2020-21 – would be met by
a margin of 0.7 per cent of GDP, down by just under half relative to our March forecast.
This measure of the deficit falls below 2 per cent in 2018-19. Public sector net debt falls by
3.0 per cent of GDP in 2020-21, meeting the supplementary debt target too. And the subset
of spending covered by the welfare cap remains below the stipulated level in 2021-22. A
new welfare cap – the fourth to be announced in four years – has been set in this Budget.
Economic developments since our previous forecast
1.9 As expected, real GDP growth has slowed noticeably this year. The fall in the pound that
followed the EU referendum has pushed up consumer price inflation and squeezed
households’ real incomes and spending. But the slowdown started slightly earlier than we
expected in March. As a result, the 0.9 per cent increase in real GDP between the end of
2016 and the third quarter of 2017 was 0.2 percentage points weaker than we expected.
1.10 This is a relatively small difference, but the breakdown of that GDP increase between
employment and productivity growth has diverged from our forecast more significantly.
Employment increased by around 230,000 over the three quarters, more than twice as fast
as expected, while average hours worked per person were broadly flat rather than falling as
we had expected. As a result, total hours worked rose by 0.7 per cent rather than the 0.1
per cent we had forecast, while output per hour rose by 0.3 per cent rather than 1.1 per
cent. This pattern of weaker productivity growth and stronger employment growth than we
had been expecting has been a consistent feature of our forecasts for some time.
1.11 The slowdown in UK GDP growth so far this year contrasts with a pick-up in other advanced
economies. Real GDP growth averaged 0.3 per cent a quarter in the UK in the first three
quarters of 2017, down from 0.5 per cent in the second half of 2016. In the euro area, US,
Canada and Japan, quarterly growth so far this year has been stronger than in the second
half of 2016 and stronger than in the UK. Sterling’s fall has seen inflation pick up more
rapidly in the UK than in the other major economies, contributing to weaker real growth.
1.12 Meanwhile, data revisions since our previous forecast have changed some aspects of the
National Accounts significantly. In particular, the ONS has revised households’ dividend
income up hugely, with an offsetting downward revision to retained corporate profits. This
now better reflects the rising number of people working as owner-managers of incorporated
firms (and taking income as dividends) rather than as employees or unincorporated sole
proprietors. This has boosted measured household income and raised the saving ratio,
although the latter is still estimated to have fallen sharply in recent years. The ONS has also
made significant revisions to the balance of payments, with interest income earned by
foreign owners of UK corporate bonds revised up substantially. As a result, the current
account deficit is now estimated to have widened to almost 6 per cent of GDP in 2016
The economic outlook
1.13 Parliament requires us to produce our forecasts on the basis of stated Government policy,
but not necessarily assuming that particular policy objectives are achieved. With complex
negotiations over the UK’s exit from the EU still underway, this is not straightforward.
1.14 The Prime Minister set out further detail of the UK’s position in her speech in Florence in
September and the Government has published a number of papers on aspects of postBrexit
policy. But there is still no meaningful way to predict the precise end-point of the
negotiations upon which to base our forecast. There is also considerable uncertainty about
the economic and fiscal implications of different potential outcomes, including the impact of any monetary policy response that might accompany them. So we have retained the same
broad-brush assumptions on productivity, trade and migration that underpinned our March
forecast (as set out in Chapter 3). These are consistent with a range of possible outcomes.
1.15 The most significant changes to our underlying pre-measures forecast since March relate to
the outlook for the economy’s supply potential, which determines how much real GDP can
grow in total over the next five years consistent with the Bank of England setting monetary
policy to achieve its inflation target. Our potential output growth judgement has five
elements. Four relate to the total number of hours that can be worked sustainably without
putting upward or downward pressure on inflation: the number of adults; the proportion
participating in the labour market; the proportion of those that can be sustained in
employment; and the average number of hours that they are willing and able to work. The
fifth and most important judgement over the medium term is potential growth in productivity
– the amount of output that can be produced sustainably from each hour worked.
We have revised each component of our potential output forecast since March:
• Population growth: we use the ONS’s ‘principal’ population projection to underpin our
forecast. New projections were published in October, with net inward migration now
expected to decline steadily to 165,000 a year by 2023, down from 185,000 by 2021
in the previous projection. More importantly, net inward migration among workingage
adults has been revised down more than the total, while mortality rates have been
revised up. Together with slightly weaker outturns than we expected, this implies a
smaller adult population, reducing potential output in 2021-22 by 0.2 per cent.
• Participation rates: we expect the whole-economy participation rate to decline as the
ageing of the population outweighs the upward trend in labour market participation
rates at specific older ages. Thanks to the latest population projections and labour
market data, the expected decline in the overall participation rate is a little slower than
we predicted in March, raising potential output in 2021-22 by 0.2 per cent.
• Sustainable unemployment: unemployment has continued to fall without much sign of
wage pressures building. This suggests that our March assumption that the economy
could sustain unemployment at 5 per cent was too high, so we have revised it down to
4.5 per cent. We still expect it to rise a little over the next few years as the National
Living Wage prices some workers out of employment. Relative to March, this raises the
level of potential output by 0.5 per cent in all years. This does not affect potential
output growth over the forecast, but provides greater scope for actual output growth.
• Average hours: average hours worked per person have risen since the financial crisis,
but to date we have assumed that the long-run downward trend will reassert itself over
the forecast horizon. However, this has not yet happened, probably because workers
have been trying to offset some of the impact of weak productivity and earnings
growth on their incomes. Given the further downward revision to expected productivity
growth in this EFO, we now assume a flat path for average hours rather than a 0.2 per
cent a year decline. This raises potential output in 2021-22 by 0.9 per cent.
Productivity growth: the largest change we have made to our economy forecast in this
EFO has been to revise down trend or potential productivity growth, as foreshadowed
in our Forecast evaluation report in October. As the remarkable period of post-crisis
weakness extends – and as various explanations pointing to a temporary slowdown
become less compelling – it seems sensible to place more weight on recent trends as a
guide to the next few years. But huge uncertainty remains around the diagnosis for
recent weakness and the prognosis for the future. We have assumed that productivity
growth will pick up a little, but remain significantly lower than its pre-crisis trend rate
throughout the next five years. On average, we have revised trend productivity growth
down by 0.7 percentage points a year. It now rises from 0.9 per cent this year to 1.2
per cent in 2022. This reduces potential output in 2021-22 by 3.0 per cent. The ONS
estimates that output per hour is currently 21 per cent below an extrapolation of its
pre-crisis trend. By the beginning of 2023 we expect this to have risen to 27 per cent.
The net effect of these revisions is to reduce the estimated level of potential output in 2021-
22 by 2.1 per cent compared to our March forecast. Growth in potential still picks up over
the forecast – from 1.3 per cent in 2018 to 1.5 per cent in 2022 – but the average rate
through to 2021 is now just 1.4 per cent a year, down 0.5 percentage points since March.
1.18 Increasing the current level of potential output, but reducing the rate at which it grows
thereafter, leads us to revise down our forecast for actual GDP growth by 0.4 percentage
points a year relative to March.
We now expect real GDP to grow by 5.7 per cent between
2017-18 and 2021-22 – down from 7.5 per cent in March. Whole economy inflation is also
expected to be weaker than we thought in March, largely because we changed our
modelling of import prices to make it more consistent with our forecast for consumer prices.
Taking the two sets of judgements together, GDP in nominal or cash terms is expected to
grow by 12.6 per cent by 2021-22, down from 15.3 per cent in March.
This implies slower growth in all the major sources of tax revenue. (The breakdown of this 2.7 percentage point
downward revision to nominal GDP growth is illustrated in Chart 1.3.)
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