Economics Weekly - UK public sector debt set to rise sharply; Weekly economic data preview - Will the UK pre-Budget Report deliver growth?
Economics Weekly 24 November 2008
UK public sector debt
set to rise sharply
A slowing economy &
tax cuts mean that borrowing will rise
This is undoubtedly the
toughest Pre-Budget Report (PBR) that labour has had to deliver since it took
office in 1997. For a start, this is the first recession the government has
experienced â€“ although one was only just avoided in 2002, helped by increased
public spending. But this time, the fiscal position is much less favourable,
with a budget deficit of 3% of gdp compared with a surplus of 1Â½% of gdp in
2000 before the sharp economic slowdown began in 2001.
The UK and world economy face
huge challenges, the likes of which the financial markets in particular have
not seen since the 1930s. In normal circumstances, slower economic growth
should lead to slower growth in tax receipts and faster growth in government spending,
resulting in increased government borrowing, but with the current financial
crisis the fiscal deficit will be even larger. This means that the deficit will
worsen due to the deteriorating economic environment - and the announcement of
additional measures to prevent the slowdown from being even more severe â€“ and measures
already announced to help offset the threat of the credit crisis. Hence, we
focus on what the Treasuryâ€™s forecasts will be given the change in the economic
environment and the additional fiscal measures that are likely to be announced.
Economic slowdown is
worsening the fiscal position and will be acknowledgedâ€¦
Slower UK economic growth is
already impacting the governmentâ€™s borrowing requirement. As chart a shows, tax
receipts are rising more slowly than spending, and below what the Treasury
forecast in the March Budget. Overall in October, receipts were rising by 0.3%
in the year but spending was up by 5.1% (against expectations in the March 2008
Budget of 4.6% growth in receipts and 4.8% in spending). This gap is evident in
net public sector borrowing, which in October was Â£37bn and Â£16.9bn higher than
in the same period last year. This compares with a full official borrowing
projection of Â£43bn for the fiscal year ending in March 2009, with five months
remaining, see chart b.
We expect the reality
of weaker economic growth to be acknowledged in the PBR, with cuts in the
previous projections taking them into line with market consensus, or lower, in
order to build in some scope for further bad news. Chart c illustrates the
extent to which the economic situation has deteriorated since March. The chart
shows that the market consensus is for UK growth of 0.8% this
year and for a fall of 0.9% in 2009. We would not disagree with the current
consensus view, although recent trends suggest that the bias of risks are
skewed to the downside of this central view, there is also a wider than usual
range of possible outcomes given the uncertainties. Inflation will likely be
sharply revised higher for this year and lower for next. One key aspect of
interest will be whether the Treasury view will be in line with that of the
Bank of England, which is looking for growth to fall by around 1 Â½% in 2009,
and inflation to drop below 1% by the end of that year, see chart d
.â€¦but a package of new
measures will also be announcedâ€¦
Although the scale of
new measures to be announced is uncertain, what is certain is that the total
will be large. The boost may be as much as 2% of gdp, which is the amount that
was mentioned at the G20 meeting in the US recently. This would
amount to about Â£28bn. This could be a combination of tax cuts aimed at small businesses
and the low paid and spending increases, aimed at projects that produce a
future return or enhance economic productivity. And VAT rates could be cut as part
of the measures. A package of this sort should in theory boost domestic demand
by 2%, though its overall economic effect will be less than this. That would
help to mitigate the economic downturn. It would not be surprising if there
were measures to help the housing sector and, like in the US, some measures to back
mortgages or to subsidise the social housing sector.
But there are also the
announcements over the last seven months to take into account, and these could come
to about Â£93bn. In May, there was Â£2.7bn, reflecting an increase in the tax
free allowance to offset the effects of the abolition of the 10% income tax
band, and later the postponement of the October fuel tax increase and that
stamp duty will not impact on properties worth less than 175,000, and the
various plans to help the financial services sector through the credit crisis.
However, some of these measures should not be included in government debt, as
they are equity stakes and so should produce an income stream in future, so
could count as investments, and are planned to be short lived.
â€¦and changes in the
As a consequence of
these changes, we suggest that the golden rule, to borrow only to invest over
the cycle, and the sustainable investment rule, to keep government debt below
40% of gdp, will probably be abandoned and replaced with strict guidelines to
get the budget back into balance in the medium term, i.e. after the current economic
crisis is over. This will result in a budget deficit in the current fiscal year
of around Â£70bn in our view and possibly Â£90-100bn plus in 2010/2011. That
would take the fiscal deficit to around 5% of gdp this year and to some 6Â½% in
2010/2011. But total UK debt is starting from a
very good position relative to other countries, see table 1, even though it
does exclude PFI projects. However, as chart d shows, it will get worse very
â€¦and greater gilt
These measures will
mean a big increase in gilt issuance. We estimate that it could rise to nearly
Â£140bn this year and Â£160bn the year after. This may have implications for the
slope of the yield curve. Although much of this is already expected in the
financial markets, so should not lead to a dramatic effect in the shorter term.
There will be immense interest about the duration of the debt, short, medium or
long and index linked or not. Gilt yields may not necessarily rise, depending
on demand from the private sector for funds and on inflation trends. But the
issue of whether this will in the long run lead to â€˜crowd outâ€™ private sector
borrowing will be a key one for some, as it implies weaker long term growth.
Whatever the outcome, this is one PBR that will not be boring.
Weekly economic data
preview W/c 24 November 2008
Will the UK pre-Budget Report
UK Chancellor Alistair
Darling presents the pre-Budget Report today at . There is speculation that public borrowing
could rise to Â£120bn over the next two years, with the knock-on effect of
pushing public sector net debt up from the current level of 43% of GDP to
possibly as high as 50% over the period. This year the PBR will attract
unprecedented attention as the impact of measures to tackle recession are fully
absorbed. On Wednesday, the European Commission is expected to announce its own
fiscal growth package, potentially totaling â‚¬130bn. The focus of economic data
lies with second estimate Q3 GDP growth, for the US due on Tuesday and for
the UK on Wednesday. Also,
the key German IFO business survey for November is released on Monday. There
are unlikely to be any surprises in this data. As global economic growth
weakens and oil prices fall below $50 a barrel, CPI inflation is falling
sharply - the US core PCE deflator and the flash EU-15 CPI for November are
published this week. The rising risk of deflation is giving central banks
further reason to deliver more interest rate cuts over the coming weeks.
â€¢ The outcome of the UK pre-Budget Report and
its implications for households, businesses and financial markets are likely to
take up a large part of the week as tax and public spending measures to avert a
deeper recession are assessed. As the week pans out it may become evident that
the stimulus package is not by itself a panacea for the economy and attention
is likely to soon switch back to the likelihood of interest rate cuts the following
week. UK data releases include
the Q3 GDP second estimate which is expected to remain unchanged on the initial
release of a 0.5% quarterly contraction, representing a 0.3% increase annually.
The Nationwide house price index for November is expected to decline by 1.7% on
the month and fall by 15.1% on an annual basis from -14.6% in October, adding
to unease about the UK housing market.
â€¢ The US has an abundance of
data releases up until Thursday's Thanksgiving holiday. The second estimate of Q3
annualised GDP is widely expected to be confirmed at -0.3%,
S&P/Case-Shiller annual house prices may exceed the August fall of 16.6%,
while existing and new home sales for October may register monthly declines. The
US consumer confidence
index is likely to stay around or fall below last month's record low level of
38.0, while personal spending could contract 0.7% in October compared with 0.3%
in September. So all in all, still a very negative economic backdrop, which together
with tumbling oil prices, have contributed to consumer price inflation falling
sharply. This is a good thing for now and will be reflected in weaker growth of
the October core PCE deflator, the Fed's preferred inflation measure - 0.1%
growth on the month compared with 0.2% in September - increasing the scope for
a Fed rate cut to 0.5%.
â€¢ We may get
clarification of the size and content of the European Commission's proposed
fiscal growth package on Wednesday, although objections by Germany may modify the initial
proposal. That aside, economic data includes the important German IFO business
survey index, which came out earlier this morning at 85.8 in November down from
90.2 in October and well off the high of 108.8 just over a year ago,
highlighting how much German business confidence has deteriorated. EU-15
industrial orders are likely to show a 1% contraction in September after a 1.2%
fall in August reflecting the current difficulties manufacturing firms in the
region face. In addition, EU-15 consumer and industrial confidence for
November, also published, will continue to be weak. The flash consumer price
index for November should fall - we expect annual growth of 2.8% compared with 3.2%
in October, giving justification for more ECB interest rate cuts.
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Mon 18 Dec
10:00 EZ- final HICP Tue 19 Dec
09:00 DE- IFO Survey
13:30 US- Housing Starts/Permits
13:30 US- Current Account Wed 20 Dec
15:00 US- Existing Homes Sales
15:30 US- EIA Crude Thu 21 Dec
03:00 JP- BOJ Decision
13:30 CA- CPI & Retail Sales
13:30 US Weely Jobless
13:30 US- GDP Fri 22 Dec
09:30 US- GB- GDP
13:30 US- core PCE Deflator & Presonal Income
15:00 US- New Homes Sales
15:00 US- final University of Michigan
17:00 US- early Closes Mon 25 Dec
00:00 Christmas Holidays
Potential Trading Opportunities
POTENTIAL PRICE RISK: Medium Mon--10:00 GMT-- EZ- final November HICP. flash data are rarely changed.
POTENTIAL PRICE RISK: HIGH- Medium Tue --09:00 GMT-- DE- IFO Survey. Key report but usually not a market-mover
POTENTIAL PRICE RISK: HIGH- Medium- Tue --13:30 GMT-- US- Housing Starts and Permits. Leading indicators of activity
POTENTIAL PRICE RISK: HIGH-Medium- Wed --15:00-- US- Existing Homes Sales. Top Housing statistic
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