Sunak ready to reap the rewards of economic recovery

Chancellor Rishi Sunak is expected to secure a windfall in public finances in the fall, as the UK’s strong economic recovery from the coronavirus crisis rapidly improves the government’s borrowing outlook, according to a Financial Times analysis.

Sunak should be given the opportunity to invest more in utilities that have been hit hard by the Covid-19 pandemic, and may even be able to cut taxes in the run-up to the next general election.

As late as the Chancellor’s budget of March 3, the UK budget watchdog predicted that the government would need to borrow £ 233.9 billion in 2021-2022 to deal with the pandemic, but the FT believes that this figure could now be as low as £ 150 billion.

Treasury officials, who have undertaken similar analyzes, said they expected Sunak to be able to deliver “good news” on the budget and public spending in the fall due to the rapid rebound. economy and the strong recovery in tax revenues.

But some officials fear Boris Johnson wants to blow up some of the manna on pet projects.

And government officials fear that if the variant of the coronavirus first identified in India gets out of hand in the UK, requiring more lockdowns, the good news of the fall budget and spending review would be much more muffled. .

The rapid improvement in the outlook for public finances in the two months following the budget has three components: the Office of Budgetary Responsibility’s miscalculation of the 2020-2021 deficit, a much stronger-than-expected recovery and signs reduction in long-term economic damage from the pandemic feared.

The government’s extraordinary response to the crisis – spending hundreds of billions of pounds on job protection, business loans and grants and the NHS – would have tested any forecaster in 2020-21.

In its initial performance review, released last month, the OBR said it made “by far the biggest forecast [errors] since the creation of the OBR [in 2010]”, And undertook to conduct a thorough investigation of these.

His “tentative” conclusion was that the main mistake he made was to take the emergency cash “allocations” from the treasury to ministries last year as an indication of likely spending when in fact the treasury kept tight control of the cash flow. All of this was not spent by the departments.

As a result, the OBR now believes on a like-for-like basis it overestimated central government borrowing by up to £ 35bn in 2020-2021. With OBR making similar assumptions about how much Treasury is allocated to Whitehall departments in 2021-2022, the watchdog is likely to downgrade spending and therefore borrowing for that year.

Part of the second OBR error was the misfortune of producing an economic forecast for the March budget in January and February, as evidence of a rebound grew stronger every day. Watchdog’s 4% growth forecast for 2021 now looks almost absurdly low, with the private sector forecast this month closing in on 8%.

Steffan Ball, an economist at Goldman Sachs, raised his growth forecast for 2021 last week to 8.1%, saying the reliable data and news flow “has been very encouraging lately.”

Bar chart of GDP growth forecast for 2021 (%) showing OBR stands out for its pessimism about growth in 2021

The outlook for 2021 – with widespread availability of the Covid-19 vaccine and an economy poised to return to its pre-pandemic size by the end of the year – follows the optimistic growth scenario much more closely. of the OBR contained in its March budget document. its central forecast.

During the first three months of this year, the OBR predicted a 3.8 percent contraction in the central forecast, but real growth was only -1.5 percent, and the economy entered into the second quarter with significant momentum.

This dynamic is evidenced by the OBR’s budget forecast errors for the month of March. As Sunak outlined big tax hikes in his budget to start paying for the costs of the pandemic, the budget watchdog believed the size of the economy was still 10% smaller than pre-pandemic levels in January 2020. The latest official data show the production deficit was 6.2 percent.

UK monthly GDP index line graph: January 20 = 100 showing Monthly economic data is already much stronger than the OBR budget forecast for March

With an economy almost as performing as the optimistic OBR scenario, public finances should also follow this improvement. The OBR said in its central forecast that it projected borrowing of 10.3% of gross domestic product in 2021-2022, or around £ 233.9 billion, but only 4.4% in the optimistic scenario, or around £ 100 billion.

The national income cash level, which is most important in determining tax revenue, is still a little further behind the optimistic scenario than actual output, but the FT analysis of its likely trajectory suggests that the Kingdom -Uni is on the way to registering a deficit of no more. £ 150 billion in 2021-2022.

However, Sunak is likely to fear that a rapid recovery does not necessarily translate into better public finances in the longer term, as the pandemic could cause deep economic scars.

But economists are becoming much more optimistic on this issue. Martin Beck, economist at Oxford Economics, said: “The apparent speed at which demand for workers is returning and employees are returning to work gives hope that the long-term economic damage from Covid may turn out to be less than expected.”

Instead of the OBR assumption of 3 percent long-term damage to the economy, the Bank of England this month lowered its estimate to 1.25 percent.

In a statement, the OBR said “there was a lot of uncertainty” about the outlook at the time of the [March] Budget, but added that it was “too early to draw any firm conclusions [about scarring] at this point. ”He said he would reconsider all of his assumptions in his next forecast.

Robert Wood, an economist at the Bank of America, said that with the government’s holiday program likely to keep unemployment peaking at nearly 5.5%, it “reduced [his] longer-term healing assumption ”along with increasing its growth forecast.

The Treasury said there were now “positive economic signs” but that the outlook was still uncertain and that it was important “to put public finances on a more sustainable basis”.


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