The UK budget will be remembered for the controversy over a proposed increase in National Insurance Contributions for the self-employed. This measure is designed to raise just £645m or less than 0.1% of total revenues in 2019-20.
Instead it was notable for the large movements of money brought about by changes in forecast. Where the Chancellor proposed modest increases in spending and taxes, each in the hundreds of millions, the number crunchers moved billions. The official forecast for borrowing in 2016-17 was lowered by £16.5bn compared to the estimate offered as recently as November. Second thoughts have led them to raise the growth forecast for the economy back to 2%, to write back into the figures considerably more revenue and to downgrade spending a bit as well. These changes bring the official forecasts for growth and revenue more into line with the Charles Stanley view. We stuck with the official March 2016 Budget forecasts which were sensible.
If the move to higher interest rates led by the USA develops, the UK too might have to raise rates a bit more than expected.
The Office of Budget Responsibility forecasts from here portray an economy continuing with a modest recovery. They expect the growth rate to shade a bit from their 2% estimate for 2017, only to get back to 2% again by 2021. 2018 marks their low point with growth of 1.6%. In that year they assume a squeeze on growth in household expenditure, a useful increase in business investment, and a further pick up in exports. We too expect a reasonably steady growth around the 2% mark from here. They say inflation reaches a peak of 2.4% this year, to fall away to 2% thereafter. Employment rises a little each year out to 2021, but not enough to avoid a small rise in unemployment to 5.1% from 4.9% over the five years. Life rarely feels that stable, but this as a prudent working hypothesis. So far employment has surprised on the upside.
The authorities may need to think more about the consequences of global events. If the move to higher interest rates led by the USA develops, the UK too might have to raise rates a bit more than expected. If Mr Trump delivers major tax cuts the UK may need to look again at its own tax competitiveness. If the US changes the way it taxes imports and exports the UK too may need to look at how it responds. The advanced world is tending towards slightly tighter money and a bit more fiscal expansion. Future UK policy will need to take this into account.
The Office of Budget Responsibility have now forecast the whole period of the UK’s likely exit from the EU, including the period of up to two years negotiating from within, and the early years out. They assume gains from trade this year and next, in excess of small losses expected in 2020 and 2021. They assume rising business investment in every year from 2018 onwards. Our view too is the likely impact of Brexit on trade and investment has been exaggerated by many commentaries. It is too soon to know whether the rest of the EU will opt to carry on with tariff free trade as their economic interests require, or whether they will insist on WTO Most Favoured Nation tariffs against their exports. If it is the latter, there is a much larger total tariff cost for the rest of the EU than the UK, given the higher level of continental exports to the UK than the other way round. The rest of the EU has considerably more exports in agricultural products, where tariffs are high. This is the most vulnerable part of EU/UK trade to any switch to WTO terms. The average tariff under WTO rules is around 3%, with much trade including all services tariff free. The large tariff income on EU agricultural and other exports to the UK could be given back to UK consumers and businesses as tax cuts. There is also likely to be considerable substitution of cheaper food from non EU sources in that event. There is the issue of non tariff barriers on services, where the rest of the EU has to weigh how much continuing access to London markets it needs, given the important role London plays in financing. We think the OBR are right not to forecast a big deterioration in this area.
This background of steady if moderate growth need induce no big worries for investors. Against this background businesses with good technology, innovative products and great service can grow and prosper.
The above article was first published by Charles Stanley on 10th March 2017.