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Budget Commentary: Fiscal tweaks – a warm-up to triggering Article 50

Neil Williams, Group Chief Economist at Hermes Investment Management, sets out his reaction to today’s Spring Budget:

Having set out his stall in November and still awaiting the main event – our Brexit negotiations - the chancellor’s fiscal tweaks today were never going to raise too many eyebrows. Sterling’s fall since the Brexit vote has so far cushioned the economic blow, allowing him a sunnier growth outlook for this year, and more optimistic tax-take. But, with the economy still vulnerable in what will be years of twists and turns in the negotiations, markets may approve from a macro perspective of his pocketing the windfall till it’s needed most.

Mr Hammond is thus sticking with his ‘Plan A’ – to ease the fiscal headwinds ahead by no longer aiming to return the finances from red to black by 2019/20 as Mr Osborne had wanted. Yet, with borrowing stubbornly high and Brexit looming, his fiscal-guard’s still up, with the squeeze just deferred. Even with the £23.5bn lobbed off his borrowing plans over five years, Brexit savings will not be enough to counter the approaching £100bn extra still needed, relative to this time last year.

As expected, there were follow-through commitments for the lower-income end and measures to promote training and technical education, but 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 may have to be tightened later if he’s to hit his deadline.

First, the deficit, while falling this year, will lift in 2017/18, and could easily go on rising if growth falls away under Brexit. Even including special items like bank sales, QE proceeds, and low interest-rate assumptions, the UK’s 2.6%-of-GDP headline deficit for 2016/17 lies around the middle of the G7 range.

Second, the recovery should have squeezed the debt more than it has. Only in 2017/18 is the net-debt-to-GDP ratio expected to peak – disappointing given real GDP is about 10% up on its pre-crisis peak. This ratio, at 89%, is more than twice Japan’s when Japan limped into a ‘lost decade’ in the mid 1990s.

Financing this debt may become more troublesome if we struggle with Brexit, 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 that the BoE keeps its QE running for too long, with the unintended consequences of further asset price distortions, suppressed saving, and increased funding strains on many pension schemes.

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