Chancellor’s looser finance targets highlight weaker UK economy

There was a veneer of discipline in the chancellor’s handling of the UK’s public finances, after he ditched his predecessor’s strict target of balancing the budget in 2020 with three looser targets to be met in the next parliament.

Philip Hammond opted to set a cap on welfare spending, but only applied the new rule from the 2021/22 financial year. He also said the government’s new aim was to bring down debt as a proportion of GDP by 2021, which George Osborne had hoped would happen under his watch.

The targets are more than five years into the future, and confirm it will take three parliaments to nurse the public finances back to health, after it became clear that a weaker economy, and not just the Brexit vote, had hit the exchequer hard.

City analysts said the looser targets were sensible when the chancellor faced a challenging two years while Brexit negotiations dominate the headlines and possibly push the economy into recession.

The government’s decision to trigger negotiations with the European Union in March and begin two years of talks is built into the latest forecast by the Office for Budget Responsibility.

The OBR, which produces twice yearly forecasts of the economy and public finances, said the talks could result in several outcomes for trade with the European Union and GDP growth, adding huge uncertainty to an economic outlook that runs until 2021.

Nevetherless, it estimated the Brexit vote would make the hole in the government’s finances much larger than its previous forecast in March.

The OBR heaped much of the blame for its forecast of a widening deficit on a dip in GDP growth next year and 2018, higher inflation and weaker earnings.

In its lengthy report, it also explained how a shift by thousands of workers into low-paid self-employment and the UK’s continuing story of low investment and low productivity had denied the Treasury vital tax revenues.

Productivity and investment were both downgraded, though remained above the levels forecast by more conservative City analysts.

The deterioration in the forecast since March this year will increase borrowing by £84bn between today and 2020/21, the OBR said, with £59bn of that related to the decision to leave the EU. A further £14bn of infrastructure spending and other measures will push the overall total of extra borrowing to £122bn.

At the heart of the infrastructure plan was a new national productivity investment fund to provide £23bn of spending over the next five years on areas such as transport, digital communications, research and development and housing.

Hammond earmarked £1.3bn for road improvements over the next five years, primarily to reduce bottlenecks, £1bn to enhance the digital infrastructure, £2bn a year in spending on R&D by 2020/21 and £2.3bn for infrastructure projects that make more land available for the building of 100,000 new homes “in areas where they are needed most”.

Whitehall spending was maintained with inflation-linked rises, though that kept in place huge cuts scheduled for local government and unprotected spending departments.

The schools budget and the NHS remain protected, though both are due to make large efficiency savings and take on extra responsibilities as part of the overall spending plan. Calls for extra cash to prevent local government services from falling over went unheeded. Likewise, cuts to further education colleges, the police, the courts service and many other public services remain in place.

Some analysts said they were surprised the chancellor chose, in the face of significant extra borrowing, to loosen fiscal policy further by funding a series of infrastructure projects.

Torsten Bell, director of the Resolution Foundation, said: “The big picture today is the new chancellor accepting a major increase in borrowing, partly off the back of the Brexit vote, and choosing to increase it further with an expensive but welcome increase in capital spending.”

Bell said that while the forecasts were “highly uncertain”, the falls in tax receipts related to broader issues that just Brexit point to a structural deterioration in the public finances.

There was a possibility an export surge or a steep rise in wages could come to the chancellor’s rescue, but analysts said it was more likely the economic situation would deteriorate and he would need to borrow extra funds to maintain government spending.

Howard Archer, chief European and UK economist at IHS Global Insight, said: “The UK GDP growth forecasts for 2017 and – especially 2018 – contained in the autumn statement are on the optimistic side. In particular, we are sceptical that business investment will pick up as much as the OBR expects in 2018 as we suspect that uncertainty will still be extremely high as difficult negotiations with the EU continue over Brexit.”

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said the OBR was also optimistic that inflation would remain well below 3%, “which we do not share”.

“The OBR thinks that CPI inflation will average 2.3% next year, lower than our 3% expectation. The OBR therefore expects a smaller squeeze on real earnings than we anticipate,” he said.

Bell argued that the focus on infrastructure overshadowed the chancellor’s decision to maintain almost all the welfare cuts put in place by his predecessor and steep cuts to vital services.

Hammond bust through Osborne’s welfare cap to achieve a small giveaway to universal credit claimants, but kept in place the freeze on payments that will hit the poorest much harder.