3 minute read

Philip Hammond’s first Budget as chancellor shows the government is still struggling to rein in the deficit despite an improved near-term economic outlook, says Stewart Robertson.

As he announced his first Budget, Chancellor of the Exchequer Philip Hammond was keen to accentuate the positive. The chancellor said the economy “continued to confound the commentators with robust growth”, putting Britain in a strong position as it prepares to embark on negotiations to exit the European Union.

Economic growth will be higher in 2017 than anticipated, according to the Office for Budget Responsibility (OBR), the UK’s official independent fiscal watchdog. The OBR now expects growth of two per cent this year, higher than its previous forecast of 1.4 per cent at the Autumn Statement in November.

However, the picture isn’t entirely rosy. Although the forecast for 2017 exceeded expectations, the economy will grow slower over the 2016-‘21 period than predicted in November. And the UK’s budget deficit will expand by £6.5 billion next year, rather than shrinking by £7.2 billion as expected, partly due to “changes in the timing of contribution requests from the EU”.

The escalating deficit gave the chancellor little wiggle room for political sweeteners. He found an extra £2 billion for social care but otherwise showed caution, pledging to save the extra tax revenues the Treasury will receive this year to provide a fiscal cushion against Brexit-related uncertainty. Hammond also risked a political controversy by raising National Insurance contributions for the self employed.

In this Q&A, Stewart Robertson, Senior Economist at Aviva Investors, discusses the Budget and what it reveals about the state of the UK economy.

 

How do the OBR’s economic forecasts compare with other growth estimates?

The near-term macroeconomic forecast has seen a big upward revision to two per cent. That’s a reflection of what we already knew, which is that the UK economy has proven remarkably resilient since the referendum last June. The OBR figures may be slightly over-optimistic – the Organisation for Economic Cooperation and Development (OECD) is forecasting UK growth of 1.6 per cent this year – but the chancellor was understandably upbeat.

Hammond announced a rise in ‘Class Four’ National Insurance contributions. Will this make much of a difference to the public finances?

The chancellor wants to close the gap between contributions paid by the employed versus the self-employed. He could have chosen to cut contributions for the employed but he has chosen to raise them for the self-employed as he tries to rein in the deficit. According to OBR forecasts, the government’s receipts from National Insurance contributions will rise to £152.4 billion in 2021-’22 from £114 billion in 2015-’16. However, the policy has been perceived as a tax hike and it is already drawing a political backlash.

The chancellor pledged to save the extra tax revenues this year rather than implementing more fiscal stimulus. Is this the right thing to do?

Yes. While I am not entirely pessimistic about the UK’s growth prospects, there are undoubtedly significant downside risks. It’s too early to conclude that Brexit is going to be a painless process. The Bank of England acted swiftly to support the economy following the referendum last year by restarting quantitative easing and cutting interest rates, which may have postponed some of the negative economic effects of the vote. And if the UK encounters difficulties in the exit negotiations it will certainly be useful to have access to a fiscal ‘war chest’ to protect the economy. This was not a Budget to be spendthrift.

Where are the potential risks to the UK economy?

Uncertainty is the big risk. There are signs uncertainty is already affecting business investment. Businesses that might have been about to embark on a hiring programme or expansion may hold off until the outcome of the negotiations becomes clearer, and that could impinge on growth.

The rise in inflation is another potential concern. A year ago inflation was zero, and real wage growth stood at 2.5 per cent. A year from now you could have inflation at three per cent and wage growth at 2.5 per cent – and suddenly real income has gone down. That would be a very different environment for consumers and reduced consumer spending would drag on growth. However, we expect the rise in inflation to be a temporary consequence of the fall in the pound and higher oil prices, and that it will begin to tick back down again in 2018.

Hasn’t the fall in sterling given UK exporters a boost?

The fall in the pound has helped exporters, but the trade benefits so far have been “relatively modest in historic terms”, according to the OBR. The office’s report says the boost to exporters will not be sufficient to offset the prospective weakening in domestic demand.

The chancellor announced new initiatives to improve productivity, including funding for PhDs in science, technology, engineering and mathematics (STEM) subjects and £690 million for local authorities to tackle urban congestion. Will this make a difference?

These are good initiatives but they are minor in the grand scheme of things. The macroeconomic effect will be negligible.

The economist Paul Krugman said “productivity isn’t everything, but in the long run it is almost everything”. But there are no easy answers. While productivity in the UK lags France, Germany and the US, low productivity is an issue across the developed world, as it is much more difficult to realise efficiency gains in services-based economies than it is in those that are more reliant on manufacturing. It is a problem policymakers will continue to struggle with.

What has been the market reaction to the Budget?

The financial markets showed little reaction to the Budget. The FTSE 100 inched higher after the speech but finished the day 0.6 per cent lower. While gilt yields finished the day modestly higher, bond yields also rose in other countries.

The market’s attention will now turn to the commencement of the Brexit negotiations. I would be surprised if the triggering of Article 50 is received smoothly across all asset markets. How the negotiations are going – or perceived to be going – will be critical in the months ahead.

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at March 9, 2017.  This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

Aviva Investors Global Services Limited, registered in England No. 1151805.  Registered Office: St Helen’s, 1 Undershaft, London EC3DQ.  Authorised and regulated by the Financial Conduct Authority and a member of the Investment Association.  

This article is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited and its subsidiaries Aviva Investors Securities Investment Consulting Co., Ltd. and Aviva Investors Pacific Pty Ltd (“Aviva Investors Asia”) for distribution to institutional/wholesale/professional investors only. Please note that Aviva Investors Asia does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia in respect of any matters arising from, or in connection with, this document.

For use In Singapore

Issued by: Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and is an Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583.

For use in Taiwan

Issued by: Aviva Investors Securities Investment Consulting Co., Ltd., a company incorporated under the Company Law of the Republic of China with registration number 53097616, holds a valid Securities Investment Consulting Enterprise (SICE) License to carry out Securities Investment Consulting Service and other relevant business permitted by Financial Supervisory Commission, Executive Yuan, R.O.C. and provides permitted liaison and co-ordination services only. Registered Office: Room D-1, 24F, No. 7, Section 5, Xin Yi Road, Taipei 110, Taiwan.

For use in Australia

Issued by: Aviva Investors Pacific Pty Ltd, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 50, 120 Collins Street, Melbourne VIC 3000, Australia.

Compliance code: 20170310_03