Economics Weekly - A Budget that did no harm? Weekly economic data preview - Good Friday for US payrolls?
Economics Weekly - 29 March 2010
A Budget that did no harm?
It is sometimes said that the first rule for Budgets should be: â€˜do
no harmâ€™. Judging by the reaction of financial markets immediately after the
2010 Budget this maxim seems to have been observed, with fairly little movement
in bonds, equities, cash or the currency. However, it is far too soon to say
whether this was a good Budget or not in the medium term, as this depends very much
on how economic and financial events unfold relative to the assumptions in the
Budget. What we do know is that, relative to the Pre- Budget Report (PBR) in
2009, there are few new announcements in the Budget at the macro level.
Although there were some headline-grabbing spending increases
(help for small businesses and for first-time buyers), most were paid for by tax
rises (some hidden, like the freezing of allowances) and in total were
relatively small, amounting to some Â£2.5bn for businesses. Hence, the alarming
increase in the Budget deficit as a result of the global recession and financial
crisis remains starkly apparent in the projections for the years ahead.
Government borrowing is expected to be smaller in 2009/10 than announced in
last yearâ€™s PBR due to better revenues (from VAT and corporation tax), at a revised
Â£167bn versus Â£178bn. The Budget deficit of 11.8% of gdp in 2009/10 is halved
in 2013/14, to 5.2% of gdp (Â£89bn) on Treasury figures. However, if optimistic
growth assumptions are not met, the deficit will likely be significantly
The UKâ€™s fiscal arithmetic makes for unpleasant reading, even after a
reduction of Â£11bn this year, Â£13bn next year and a cumulative Â£100bn less than
projected in the 2009 PBR. Over the period to 2014/15, when the deficit is
expected to have fallen back to 4% of gdp, borrowing is expected to have
totalled Â£734bn. This will roughly double the net debt to gdp ratio from its
level prior to the recession, to 75% of gdp in 2014/15. With Â£39bn of spending
cuts and tax rises already announced, the reduction in the deficit to Â£89bn in
2013/14 is courtesy of fast growth in gdp, officially projected at 3.25% next
year, and 3.5% in future years.
The Treasuryâ€™s GDP projection for 2010 was left unchanged in todayâ€™s
Budget at a midpoint of 1.25%. Although this is above our own forecast of 0.7%,
it is in line with the consensus. Where, however, the Treasury departs company
from both ourselves and the consensus is in its optimistic forecasts for growth
in 2011 and
thereafter. The Chancellor is clearly relying on a broad and deep
economic expansion over the coming years. The combination of a cyclical recovery,
an upbeat view on the prospects for trend growth and the lower starting point
for borrowing enabled the Chancellor to project a further improvement in the
public sector finances. It remains to be seen whether such optimism is
justified, but we doubt it.
The centerpiece of the Budget was a package of Â£2.5bn to support
small businesses, including a temporary rise in the level of small business
rate relief and a doubling of the Annual Investment Allowance to Â£100,000 and entrepreneursâ€™
relief to the first Â£2m of gains. Other measures included new bank lending commitments
to homebuyers and businesses of Â£105bn, including Â£67bn from Lloyds Banking Group,
as well as the establishment of UK Finance for Growth and a Green Investment Bank.
Despite the perception that financial market reaction to the
Budget has been universally negative, the data do not entirely bear this view out.
Looking at chart d shows that the FTSE-100 has risen in every session since
then, after languishing in the week running up to the Budget. This seems odd,
though it could be that the Budget at least ended the uncertainty about what
was going to be in it. 10-year bond yields are higher, even though borrowing
for the full year was cut by Â£11bn to Â£167bn. Perhaps this rise in yields
reflects the lack of detail about where the Â£39bn of measures to take the
deficit down to Â£89bn by 2013/14 was coming from. (The budget deficit is
projected to fall by Â£78bn from this year to Â£89bn in four years. Of that fall,
the Budget showed that Â£19bn was coming from tax rises and Â£20bn from spending
cuts but did not show where the other Â£39bn was coming from. It is this that
could have pushed up gilt yields).
Three month Libor rates remained unchanged, likely reflecting
market perceptions that the Budget did not alter the timing of the next move in
UK official short term interest rates. On a trade weighted basis,
the pound continued to weaken, and the Budget appeared to have played little
direct part in that trend. It can be observed from the chart that the pound was
weakening prior to the Budget announcement and stayed low after it. From a
short-term market perspective, the Chancellor seems to have succeed in the
maxim, â€˜do little harmâ€™. In the medium term, the jury is decidedly out on whether
this was the right Budget to deliver at this time.
ô€‚„ All eyes will be on
this weekâ€™s key release, the March US Employment Report. The report is expected
to deliver the first sizeable increase in US payrolls since November 2007.
After declining by 36k last month, partly due to bad weather, payrolls are
forecast to have recovered by around 200k in March. Over recent weeks, leading
indicators of the US labour market have continued to improve. The employment component
of the latest manufacturing ISM, for example, is currently at its highest since
November 2005. Against a firmer employment backdrop, the unemployment rate is forecast
to drop from 9.7% to 9.5%. This weekâ€™s numbers could mark a clear turning point
for the US labour market although, given the challenges still facing the US
economy, it is likely to be some time before payrolls are posting sustained
monthly gains of 200k plus. Given its importance, a strong payroll could prompt
a significant market reaction, especially as the closure of markets in Europe for the Good
Friday holiday is likely to mean liquidity conditions are thin. Apart from the
labour market data, this weekâ€™s US calendar also includes the latest Chicago PMI and ISM
manufacturing surveys. We expect both reports to build on the gains in recent
months. US consumer confidence, personal income and spending, and house
price data are also due.
ô€‚„ As we approach the
end of the first quarter, the statistical noise surrounding many of the recent
data releases continues to cloud the underlying view of the UK economy. Last weekâ€™s retail sales figures were a case in point.
Although retail sales jumped by 2.1% in February, the impact of the increase
was substantially tempered by a marked downward revision to the January
outturn, as the extreme weather conditions that month played havoc with the
data. It is not only the retail sales report that has been volatile: the recent
industrial production, labour market, PMI and CPI reports have also been
sending mixed messages. The market should get a better sense of the economyâ€™s
underlying strength from the forthcoming March data. This week sees the first
of the key March releases, namely the manufacturing PMI. In recent months this
survey has posted a strong recovery, underpinned by the fall in the pound,
rising global trade and a slower pace of destocking. The results of our latest
in-house Business Barometer, however, suggest that the pace of improvement was
not sustained over the past month. As a result, we look for the manufacturing
index to drop back to 56.0, from 56.6 in February. Another important UK release this week will be the final Q4 GDP report. Although less
timely than the PMI, the survey will contain more detail about the forces
shaping growth in the latter months of 2009, including the household saving
ratio. Accompanying the GDP report, the Q4 current account figures will be
watched for an indication of whether the UKâ€™s imbalances are improving. We expect little change. Also this
week, the latest UK consumer credit, mortgage lending and approvals figures are due
along with the BoEâ€™s Credit Conditions Survey for Q1.
ô€‚„ For now, the focus
in the eurozone remains less on the economic data and more on the fiscal
travails of Greece and some of the other peripheral EMU members. The support package
agreed by eurozone leaders last week represents a positive step forward,
providing the euro exchange rate with some much needed solace, at least for
now. The prospect of any sustained improvement in the euroâ€™s fortunes, however,
could well be tested if, as expected, this weekâ€™s US data surprise on the strong side. Although unlikely to be major
market movers, the eurozone economic calendar is fairly busy this week. Amongst
the more important releases, the latest CPI and employment figures are due in Germany, while later in the week, the EU-16 flash CPI and European
Commissionâ€™s confidence surveys are published. We expect the overall tone of
this weekâ€™s eurozone economic releases to be slightly firmer, consistent with a
slow economic recovery.
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