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UK growth forecast revised down

By Alice Tarleton, Faisal Islam

Updated on 14 June 2010

The independent official forecaster cuts the rate at which the UK economy is expected to grow. Channel 4 News's Economics Editor Faisal Islam says the numbers are not significantly worse than expected, but predicts savage spending cuts ahead.

Economy forecast for UK may be revised down

The independent Office for Budget Responsibility (OBR) forecasts growth of 2.6 per cent in 2011, below the 3.25 per cent predicted in March's budget.

But the fiscal watchdog predicts the government will borrow £155bn in the current financial year - less than the £163bn forecast by Alistair Darling in March. The new forecasts expect the UK to borrow a total of £22bn less than expected over the next five years, plus £10.4bn less than expected last year.

The data gives the first concrete sign of the task ahead of the coalition government, which has pledged to tackle the budget deficit with heavy spending cuts.

"The good news for Mr Osborne is that the improvement in the deficit numbers may obviate the need for an unpopular VAT rise," wrote Economics Editor Faisal Islam. "The bad news is it turns down the temperature a little on the need for a much faster rate of deficit reduction."

Economics Editor: Faisal Islam's analysis

The release of Sir Alan Budd’s independent Office of Budget Responsibility forecast is an extraordinary moment in Britain’s economic management, writes Faisal Islam.

Firstly, it’s immensely impressive that this new government has eschewed the power to cook the books. It is an important, useful power that enables governments to squirrel money away, time tax cuts, and generally abuse statistics for partisan purposes.

It has been in chancellor’s prerogative since the 1974 Industry Act. It is a brave chancellor that gives up this power.

However, my second point is that today’s OBR has far from backed up the current government line on the deficit. Nick Clegg, the chancellor and the prime minister have lately all been claiming that their initial look at the books has unearthed various subterranean horrors lurking in the hidden cells of the Treasury spreadsheets, hidden by a dying, desperate Labour government. The government should promptly retire this line of argument.

- Read more on Faisal's blog and follow Faisal on Twitter.

When the deficit is lower in each and every year, and the overall level of borrowing £32bn lower than at the March 2010 budget, it is difficult to sustain the suggestion that the coalition has unearthed an extra fiscal black hole.

Perhaps the best illustration of this is the fact that barely ten minutes after the forecast was presented, a senior aide to the chancellor explained why the OBR were “understating the extent to which [the public finances] are worse than thought… potentially by a significant amount”.

There are two reasons for this: this forecast is not cautious (the Treasury normally factors ‘caution’ in by assuming higher unemployment and lower tax receipts than expected, not the OBR), and it assumes market interest rates (which already factor in a likely additional government cuts programme).

But it is unquantifiable, and is counterbalanced by the fact that the already announced £6bn of cuts aren’t included in this forecast.

So overall, the chancellor has not got the mandate for radical further action he would have ideally liked from this report.

Of course it does illuminate that Alistair Darling had already pencilled in £44bn of cuts before the election, but the new chancellor cannot credibly blame his decision to accelerate this on a ’shock’ in today’s report.

Next week’s epic budget will see additional cuts or tax rises made out of political choice rather than through objective economic necessity.

The chancellor could though choose not to put VAT up, for example. But here’s my current best guess: Chancellor Osborne is going to go for it. He wants to eliminate the entire structural deficit, possibly even during this parliament (2.8 per cent of GDP in 2015 would mean an extra £46bn of cuts or tax rises).

He would like to start to actually lower the national debt, not just the rate of its growth. So VAT up, a raft of green taxes too, alongside a fundamental downsizing of the state, dressed up as ‘unavoidable’ spending cuts.

Previously, official growth and borrowing forecasts were calculated by Treasury officials and signed off by the chancellor.

In March, Darling predicted the economy would grow by 3-3.5 per cent in 2011. This was not out of line with the Bank of England's prediction, but was more optimistic than many other independent commentators.

If the OBR revises down the Treasury's growth forecasts by 1 per cent of national income, the gap between tax revenues and spending increases by around £10bn.

However, the latest public finance figures showed the government had needed to borrow less than it expected in the last financial year.

Shadow Chancellor Alistair Darling attacked the government's claim that the public finances are worse than expected. "Borrowing is lower than I forecast, so the idea being put about by the prime minister and chancellor last week that there was some hidden borrowing simply isn't true, and they don't have the political cover they were looking for to put up VAT and cut public spending next week," he told Channel 4 News.

In a speech this afternoon, Deputy Prime Minister Nick Clegg said the forecasts showed our problems are "more serious than we realised" and that "we have to get on with putting things right".

"We and many others have been warning for some time that the growth forecasts in the March budget was optimistic," he said. "The OBR confirms this. Because trend growth is lower than expected, the structural deficit is larger than anyone realised."

Although the overall borrowing forecasts are reduced, the new forecasts are less optimistic about the structural budget deficit - the underlying hole in the economy not expected to disappear as a result of growth, which George Osborne has pledged to tackle.

The budget thought this would be 7.3 per cent of GDP in the current financial year; the OBR increases this to 8 per cent. By 2014-15 the Treasury had it pencilled in as 2.5 per cent of GDP; the OBR increased this slightly to 2.8 per cent.

"On face value it suggests we don't need to take as drastic action to bring overall borrowing back down. But if you dig a little deeper, the picture's not quite so reassuring," said Vicky Redwood of Capital Economics.

"It suggests that less of borrowing will come down naturally as the economy recovers and there's more of a structural deficit or black hole in the public finances, and that will need to be filled by higher taxes or lower spending."

The ups and downs of the black hole: how forecasts change
The amount Labour expected to borrow in 2009-10 rose massively during the recession, but has declined in recent months:
- Budget 2008: £38bn
- Pre-budget report 2008: £118bn
- Budget 2009: £175bn
- Pre-budget report 2009: £178bn
- Budget 2010: £167bn
- OBR forecast: £156bn

'Clean slate'
The man in charge of drawing up the new forecasts emphasised that they were "very uncertain".

"We do have to think of this as a completely new forecast," said Sir Alan Budd. "We started with a clean slate - of course the Treasury has helped us produce the forecasts, but we have put our judgements into them and we have reached different conclusions," he said.

The revisions to the growth forecasts were "partly to do with what's been happening in the recent past," he said, but he pointed out that the changes were "within the normal range of uncertainty".

The OBR has also cut the expected size of the national debt slightly. It's now predicted to reach 62.2 per cent of GDP in the current financial year - down by 1.5 percentage points on the budget prediction. By 2014-15 the OBR predicts UK PLC will be indebted to the tune of 74.4 per cent of GDP - just half a percentage point less than the prediction in March.

The government announced £6bn of immediate spending cuts, including the scrapping of the child trust fund, last month. The effects of these is not included in the OBR's forecasts.

It is holding an "emergency" budget next Tuesday and will set out detailed spending plans for the next three years in the autumn.

Last week David Cameron said the cuts ahead would change our way of life.

The Chancellor, George Osborne, set out plans for a far-reaching review of public spending last week, saying it was a "once in a generation" chance to reassess national priorities. The interim OBR is led by a three-strong budget responsibility committee, headed by Budd.

Shortly after taking office in 1997, Labour gave responsibility for setting interest rates to the Bank of England's independent monetary policy committee.

Faisal Islam's analysis: diagnosis rather than cure
"The chancellor has had the legal right to sign off on each forecast since 1974," Channel 4 News's economics editor said before the report was released. "This is the first time an independent forecast will be presented for the budget, and it could plausibly worsen the deficit problem by tens of billions of pounds in the coming years if growth is downgraded.

"What I think you get today is diagnosis of the problem rather than medicine or cure. On the whole it's an attempt to set out that the tough decisions will get next week are in urgent necessity rather than a political point."

- More economic analysis on Faisal's blog

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