14 Jun 2010

New economic forecast brings unexpected problems for coalition

The OBR experts have just released their analysis. Here is my instant take.

This is not a mandate for a much sharper axe.

Projected economic growth has been downgraded by about half a per cent in each of the coming years, suggesting that the independent experts believe that the Labour government painted a rosy picture of the economy.

The Office of Budget Responsibility has also downgraded the economy’s “trend rate” of growth to 2.1 per cent, by 2014-15.

But the real revelation here is that all of these effects, that would be expected to make the deficit worse, have been far outweighed by the improvement in economic conditions fostered by the previous government.

Overall expectations of government borrowing are markedly less now than at Alistair Darling’s last budget in March.In fact the difference between the March 2010 forecasts and these ones is £32.4bn less borrowing by 2014-15.

This is the effect of better tax receipts and lower unemployment benefits washing through the next few years, and the OBR experts removing very cautious assumptions made by Mr Darling.

Net borrowing will now drop to less than 4 per cent of GDP by 2015. The OBR itself says: “These improvements are driven by the expected recovery of the economy over this period and by the policy measures announced by the previous government to reduce the deficit.”

Mr Osborne’s favourite measure though is the “structural deficit”. Because trend growth is smaller, the OBR forecasts that the structural deficit will be higher (though only just by 0.3 per cent).

Clearly there are two ways to look at this: the deficit is beginning to sort itself out, and it is time to make the already implied degree of cuts more credible (Labour’s position). Or the economy is strong enough to warrant an even more savage axe (the Conservatives).

For example, the OBR has shown that “the bulk of the structural deficit” (Mr Osborne’s election aim) is already being eliminated under existing plans, going from 8.8 per cent this year to 2.8 per cent in 2015.

I’m not sure this justifies a change of course on raising taxes, for example. It also strengthens the hand of the more dovish elements of the coalition.

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

The independent budget experts have unexpectedly presented the chancellor with some problems.