The threat of Brexit aside, the economy looks set to continue improving, says Kitty Ussher
Regardless of the politics of the matter, the main news from last month’s budget is that the economy is in good shape. Of course, that is not to say there is not room for improvement, or that our country is structured in a way that would make a progressive proud; we can return later to our 10-point plan for the next manifesto. I am talking instead about the top-level economic picture.
As a wealth-creating machine, our economic engine is now bigger than it ever was and the Office for Budget Responsibility, the custodian of the official forecasts, expects it to keep growing steadily, driven by confident consumers, strong business investment and stronger exports. Inflation will remain low, it says, only rising slowly from the freaky zero recorded last year to reach the Bank of England’s target rate of two per cent in two years’ time.
This, plus some nervousness in the financial markets in the new year, has delayed yet again the long-awaited rise in interest rates, not now expected until 2019. Great news for the 10 million or so British households with a mortgage.
It is good news on the jobs front too. In every single forecast it has made since its creation, the OBR has revised its forecasts for employment upwards, and this time was no exception. The economy is now expected to support a massive 31.5 million jobs in 2016 and the unemployment rate is as low as it has been at any time in the last 40 years, at around five per cent.
With a strong economy comes stronger bargaining power for employees. The number of job vacancies is also soaring which, through the usual forces of supply and demand, pushes up wages: more real pounds in people’s pockets, particularly given inflation is low. Was Labour right in the last parliament to tell everyone their wages were falling? Real average earnings have in fact risen by two per cent in the last year.
With this good news backdrop it would be reasonable to assume that the government’s own finances would also be improving. However, rather unfortunately for the chancellor, the speed at which the OBR expects this to happen has been pushed back, causing him to miss his stated target that the stock of debt should start falling in the 2015-16 financial year (it will happen next year instead) and requiring further policy changes to ensure that there will still be a surplus on the deficit by the end of the parliament.
The reason is that the OBR has slightly reduced its forecast of the pace at which the economy is expected to grow, presuming that the lower than expected productivity figures that came in at the end of 2015 mean that productivity will be lower than previously thought into the future as well. However, this is a major assumption that might not be borne out in practice. Indeed, the OBR itself admits that this is ‘the most important uncertainty in … our economic forecast’.
In fact there are other perfectly plausible reasons why the data at the end of last year was not quite as expected, first among which is the surprising ability of the economy to grow through adding more jobs and hours before raising the productivity of those jobs. Another is that businesses are starting to delay investment decisions until the European Union referendum is out of the way, as some private sector surveys are already showing.
I suspect that the Treasury privately disagrees with the OBR, and expects a surge in productivity once the unemployment rate reaches its lowest point. Clues are that its policy response to the worsening debt figures lack substance: it is mainly a rephasing of existing policies, notably planned changes to the timing of corporation tax payments so that the windfall to the Treasury comes in the target year of 2019-20, and then making up the remaining gap from an ‘efficiency review’ that will not report until 2018, by which time the picture could look very different.
Further evidence of Treasury scepticism comes from its refusal to identify further cuts to make up for the U-turn on personal independence payments; instead it preferred to wait until the next official forecast which conveniently is not scheduled until the end of the year, by which time a lot more data will be available. If my argument is right and the OBR is overly pessimistic about productivity, we will need to be politically ready for a future budget or autumn statement that says the debt and deficit targets will be met far earlier than currently expected.
But before we get there, another omission from the OBR’s forecast will become very apparent, and this one works in the opposite direction. It has made no allowance for the effects of uncertainty around Britain’s EU membership: its job is to base their forecast on government policy, and since the official government line is to remain in the EU, that is what it presumes.
So there is nothing about turmoil in the financial markets every time Boris Johnson opens his mouth, nothing about how this affects the all-important issue of consumer confidence, nothing – as we have seen – around business investment slowing this side of 23 June, and nothing except a carefully worded box summarising other (negative) evidence about how its own forecasts might change if the ‘Leave’ campaign wins.
Put all this together, and my prediction is that the economy will underperform in the short term and then start to overperform towards the end of the year and onwards, presuming the EU vote is won by the pro-Europeans. (If we vote to leave, all bets are off.) So that is the economic backdrop to start working on that 10-point plan.
Kitty Ussher is managing director of Tooley Street Research and a contributing editor to Progress
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