Chancellor lowers economic growth projections, preaches
stability and increases borrowing
Leading business and financial adviser Grant Thornton says that
Alistair Darling's first budget, delivered against the backdrop of
a slowing economy, stayed true to predictions and raised revenue
through green taxes while offering little in concessions to UK
business or individuals.
Given the current state of the economy and public finances,
Grant Thornton's chief economist, Stephen Gifford, believes Darling
could do little else with his first budget but hope to stem the
tide of a slowing economy and try to shore up the public finances
with tax rises on such things as polluting behaviour, Vehicle
Excise Duty and alcohol. Overall, the tax burden is predicted to
increase by £0.8 billion in 2009-10 and by £1.9 billion in
2010-11.
"In essence, Darling's budget was the placating dummy offered to
an economy on the verge of a tantrum," says Gifford.
The Budget sets out some remarkable changes in the expectations
for the public finances. Public borrowing over the 2008-09 to
2011-12 period is expected to be some £20 billion higher than in
December 2007. The Sustainable Debt Rule, which states that
the aggregate stock of public debt must not exceed 40% of GDP, is
forecast to grow to 39.8% by 2010-11, only a whisker away from the
target. Gifford notes, "These changes in the public finances
since October 2007 are remarkable and illustrate the worrying
effects that the credit crunch is now having, not just on the
financial sector but on the whole of the UK economy."
Aside from delaying the 2p rise in fuel duty, scheduled for
April, until October this year, and moves to fight child poverty,
Gifford says there was little to cheer about for both business and
individuals in the budget, with Darling choosing to "hold the ship
steady" rather than create any further wholesale changes to tax
policy.
"It seemed Darling was more interested in espousing the virtues
of the UK's resilience to the credit crunch compared with the
weaker performances of its peers, than offering an olive branch to
the taxpayer," says Gifford. "As for the green budget, the truth
was that he tweaked existing green initiatives but made no real
bold moves."
What's in store for the UK economy?
"The UK is living amidst a climate of global economic
uncertainty. There's doubt about what the full effect of the credit
crunch will be, doubt about the effects and costs of climate change
and insecurity in the financial and property markets. It would
appear Darling has decided that prudence and stability is key and
has largely maintained the status quo."
"The UK has enjoyed solid growth over the last 15 years with
2007 being particularly successful for the country when GDP rose by
3.1%, well in excess of the long term trend. The UK had a fast
growing financial services sector, a healthy housing market and a
confident consumer base, which have all been major contributors to
this success. However, that is now a fleeting memory. The
Chancellor is now trying to appear to do all he can to prevent the
financial credit crisis turning into a serious economic slowdown
without actually changing much" Gifford says. "He is hampered from
doing anything major with tax, due to the perilous state of the
public finances and the inflation risks that have built up".
The Treasury is expecting growth in 2008 to be between 1.75% and
2.25%, before strengthening to 2.25% - 2.75% in 2009 and 2.5 - 3%
in 2010*. It expects this to be driven by low inflation, record
levels of employment and low unemployment. Furthermore, the
Treasury expects this to be combined with the government meeting
its strict fiscal rules, supported by the current budget currently
showing an average surplus as a percentage of GDP over the current
cycle and that public sector net debt is expected to be maintained
below the 40% target.
Gifford is not as optimistic, "GDP is more likely to grow by
only 1.7% over the course of the year. Inflationary pressures will
also remain a serious concern with the Bank of England unable to
cut interest rates as fast as it would like to shore up the
economy." Some departments may struggle to live within their public
sector spending limits, especially on pay, placing ever greater
emphasis on the public finances and the need to make policy
delivery effective and efficient.
As for what the rest of the year holds, Gifford says it is
difficult to predict with any certainty exactly what the economy
will do amidst the current climate of uncertainty, but he cites the
following four issues as key drivers of where the UK's economy will
head:
1) The credit crunch - The full ferocity of the credit
crunch is expected to show its claws as 2008 progresses as the
uncertainty about the size and location of losses begins to unfold.
There is an expectation of lower bank lending and decreases in
M&A and market activity which could potentially lead to
declining levels of investment. Potential decreases in individuals
being able to obtain credit also contribute to an economic slowdown
and a feared recession.
The impact of the tightening lending regime by banks is beginning
to impact on corporate bank borrowing. Credit conditions for firms
are tightening which will impact on investment. Although
profitability and liquidity outside the financial sector is high,
mitigating some of the impacts, the investment outlook is weak with
UK investment growth of only 2% expected in 2008**.
2) Personal debt in Britain has become an increasing burden in
2007 and is likely to heap further pressure on families and
households through 2008. Britain continues to hold the highest
amount of personal debt of any European country***, and summer 2007
saw the total borrowed in the UK exceed Britain's GDP for the first
time.
The problem is predominately secured debt such as mortgages
which has been getting larger due to the rising gap between house
prices and incomes and increases in interest rates over the past
few years (rising from 3.5% in Summer 2003 to 5.75* by Autumn
2007). Nearly two million households at the end of 2007 who were
moving from low interest fixed term mortgages are now expected to
get hit by higher variable mortgage rates****. This is leaving
people more sensitively exposed to any economic changes and may
well lead to decreased consumer spending and an increase in the
volume of house repossessions.
This will have a knock-on effect to tax receipts, but it is
expected that this will become more apparent in 2009.
3) Rising oil prices - Following the Bank of England's
fourth quarterly bulletin in 2007 it was discussed that rising
energy prices will remain an important influence on any future
interest rate decisions*****. Rising oil prices from $55 a barrel
in January 2007 to almost $109 a barrel at Tuesday 11 March 2008,
are having a direct impact on inflation and are putting pressure on
both business and consumers.
4) Rising energy prices - Following tougher legislation, supply
side pressures and 'the carbon footprint', energy companies have
been significantly increasing their prices. This is impacting on
household disposable income which is putting downside pressure on
consumer demand and has pushed an estimated 4.5 million consumers
into fuel poverty according to web site uSwitch.com.
Government concern at rising energy prices coupled with
increasing profits in the sector may be a factor behind the Ofgem
probe of energy markets. A budget decision to impose a
windfall tax on energy companies could have important implications
for future prices and investment in the sector.
However, strong employment and wealth at record levels may well
give households the confidence to maintain their spending levels,
for the time being.
*HM Treasury - 2007 PBR CSR: meeting the aspirations of the British
people
** HM Treasury - Forecasts for the UK economy (February 2008)
***OECD
****financemarkets.co.uk - Threats for the UK economy in 2008
***** Bank of England - Current monetary policy issues - quarterly
bulletin 2007 q4