Don't worry, Darling
9 December 2009
All eyes in the UK today were on Chancellor Darling, as he unveiled his 2009 Pre-Budget Report (PBR), which provided an update on the government’s economic and fiscal projections along with some relatively minor, although eye-catching, tax and spending plans. Unsurprisingly, the PBR revealed a downward revision to the Treasury’s growth forecasts. Darling now expects GDP to shrink by 4.75% this year, compared with a forecast fall of 3.5% in the Budget. But despite this sharper decline in activity, his forecast for 2010 was little changed at 1%-1.5%Y/Y, while GDP growth in 2011 and 2012 is expected to be 3.5%, unchanged from the Budget. These unrevised growth forecasts, despite the sharper fall in GDP in 2009, contrast with the Bank of England’s latest projections, which were revised up in November following disappointing activity data. So Darling appears to have adopted a slightly more cautious growth outlook than the BoE.
At the same time, the Chancellor also set out his revised public finance forecasts. Public sector net borrowing (PSNB) for FY09/10 is now expected to total £178bn, only a little higher than the Budget forecast of £175bn. Borrowing is expected broadly to stagnate in FY10/11, at £176bn, before then falling over the lifetime of the next parliament, reaching £82bn by FY14/15. In terms of GDP, that means that this year’s 12.6% deficit will edge down to 12% next year, and then fall more sharply, to reach 4.4% of GDP in FY14/15. That, though, falls short of the European Commission’s calls for the deficit to be reduced below 3% by that date.
News? What news?
Source: HM Treasury
With such large deficits, the Chancellor was in no position to offer a further stimulus package, despite the UK being the only G20 economy still in recession. There was the usual raft of small-scale announcements – but the Chancellor’s main aim was to draw a political line between the government and the opposition. For example, he refused to remove the fiscal support to the economy too quickly, arguing again that fiscal tightening should not be imposed until the economic recovery is firmly underway, in 2011. But despite this, today’s announcements gave precious little detail on future changes to spending and taxation, beyond confirming that VAT will return to 17.5% on 1 January 2010, and other headline-grabbing but ultimately low cost or low revenue-raising measures, such as the tax on banks’ bonus pools.
Nonetheless, Darling’s plans still imply that the deficit will more than halve (as a share of GDP) by FY13/14. Indeed, separate legislation will commit the government to this aim. This plan has been criticised as not ambitious enough in some quarters, although BoE Governor King has been careful to temper his remarks by noting that any fiscal consolidation must take into account the state of the economy. And we would agree with Darling that attempting to reduce the deficit too quickly – next year, for example – could hamper the economic recovery, with private demand still showing few signs of taking up the baton of growth in the UK.
All told, the impact of today’s PBR on the macroeconomic outlook is negligible, with no large-scale tightening of fiscal policy next year. But the commitment to deficit reduction over the medium term, if achieved, would see the debt-GDP ratio peak at 78% in FY14/15, which would be sufficient for the UK to retain its AAA status. Of course, setting out a path for consolidation and subsequently carrying it through are two entirely different things. But with both of the main political parties talking tough on the need for consolidation after the election next year, it would take a further deterioration in the fiscal outlook for the ratings agencies to begin seriously considering a downgrade for the UK.
Colin Ellis, European Economist
Katherine Dann, Junior Economist
Disclaimer:
This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.
This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.
Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at http://www.daiwausa.com/.
For more details, please contact:
Colin Ellis, Fixed Income Research
Daiwa Capital Markets Europe Limited
5 King William Street, London, EC4N 7AX
+44 (0)20 7597 8339
For up to date Research analysis, see our blog site here.