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Hermes: Fiscal slippage not halted by Brexit savings

Neil Williams, Group Chief Economist at Hermes Investment Management, sets out his reaction to today’s UK Autumn Statement.

Today’s Statement was always going to signal the extent to which chancellor Hammond has kicked austerity into touch, though in the event not as much as some would like. The Treasury is no longer aiming to return the finances from red to black by 2019/20. Yet, with borrowing lifted again and Brexit looming, the chancellor is not going to let his fiscal-guard down completely: the squeeze is just deferred.

An underlying surplus is still targeted, but now not till about 2022/23. And, with lower-than-planned tax revenue since the spring Budget and softer GDP assumptions going forward, he’s inferring Brexit savings will not be enough to counter the £122bn extra borrowing over the next five years.

This fiscal slippage amounts to a meaty 5 percentage points of GDP compared with the Budget. And, while this is limited by funds still in his ‘back-pocket’ from bank proceeds and the BoE’s deferral of asset sales, the peak in the debt stock, at around 90% of GDP, is pushed back another two years.

As expected, there was help for the lower-income end and savers, and also follow-through commitments on infrastructure and corporation tax to help firms in the Brexit firing line. But, there were few ‘rabbits out of hats’. And, while helpful to longer-term growth and competiveness, his measures short-term may have more micro than macro effects on the economy.

So, let’s not get carried away. The fiscal screw will have to be tightened later if he’s to hit his new deadline.

First, the deficit is still high. Even including special items like bank sales, QE, and milder interest-rate assumptions, the 3.5%-of-GDP headline deficit for 2016/17 will still be the G7’s widest after Japan.

Second, the recovery should have squeezed the deficit more than it has. While the headline deficit falls, the structural, less growth-sensitive part will fall by less.

And, only in 2017/18 is the net-debt-to-GDP ratio expected to peak – disappointing given real GDP is about 8% up on its pre-crisis peak. This ratio, at about 90%, is more than twice Japan’s was, when Japan limped into a ‘lost decade’ in the mid 1990s.

Financing this debt may become more troublesome if we struggle with Brexit. Conventional gilts may benefit initially from the perceived hit to growth, but this could be short lived, given about one third of gilts outstanding is backed by international investors who will care about currency and ratings risk. This would disrupt the OBR’s low gilt yield assumptions.

In which case, the risk is the BoE extends its QE, with the unintended consequences of asset price distortions, suppressed saving, and increased funding strains on many pension schemes.

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