Why Was Growth Downgraded in the Budget?

Chancellor Philip Hammond revealed in yesterday's Autumn Budget that UK economic growth forecasts have been downgraded

Emma Wall 23 November, 2017 | 9:52AM
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Emma Wall: Hello and welcome to the Morningstar Series "Market Reaction". I'm Emma Wall and joining me today is Rathbone's Ed Smith to talk about the budget.

Hi Ed.

Ed Smith: Hello Emma.

Wall: So of course, like any chancellor, Philip Hammond yesterday tried to deliver a positive message about the UK, saying that he was going to build a Britain fit for the future. But hidden in a lot of his positive rhetoric, was the fact that the economic outlook for the UK has been significantly downgraded.

Smith: For sure and downgraded to really quiet a large extent. This is the first time since the Office for Budget Responsibility started doing the forecast. That growth is expected to be below 2% in every single one of the five years forecast. Its expected to average just 1.4% over the five years. And that puts UK growth right at the bottom end of the spectrum when we look at expected growth across advanced economies.

Wall: I suppose this is a very simple question and there may not be a very simple answer. But why the downgrade, why does the outlook for the UK economy now look worse than it did a year ago.

Smith: It's largely to do with the outlook for productivity. So, like pretty much any forecaster the OBR, over the last seven years has forecast productivity to return to around about the 2% trend, three years out. But UK productivity and productivity globally actually the UK is not unique in this. Productivity has disappointed time after time, quarter after quarter and in fact actually this year productivity growth in UK is likely to be negative which is a really dire outcome for an advanced economy, which relies on productivity to really grow, because demographics aren’t with us and we've got plenty of debt.

Wall: So, downgrade in economic outlook, a downgrade in productivity. There was some I suppose good news in the fact that Philip Hammond expects our debt-to-GDP to peak before waning next year, peak at 90%. Now that doesn’t sound like too much to boast about, 90% debt-to-GDP, but it is lower than some of our peers although it is higher than the European recommendations for debt-to-GDP isn’t it.

Smith: I mean 90% would still place us probably second or third, probably give us the second or third lowest debt-to-GDP ratio in the G7 economies. The US over the forecast period would probably get up to between 120% to 130% of GDP. Japan obviously under 200% now. So, I think it’s really not something to boast about because the Conservative government or the coalition government originally thought debt was going to peak some years ago in the middle of this decade. And they have consistently missed those targets. And I think and the main reason why they've consistently missed those targets, is because of growth and of course the downgrades today are compounding that.

Wall: This seems like a very gloomy chat. We've talked about negative productivity growth, negative economic growth or at least downgraded economic growth and now we're hearing that actually the debt forecast may not even be true either. Is there anything to be cheery about?

Smith: Well, I think what's important to take away is that it's low growth not recession. We're talking in very gloomy terms and often when we are talking gloomy terms we are predicting recession which usually means a bear market for investors. We're not saying that. The good news is that a lot of the gloomy expectations are already baked in two things like the sterling exchange rates. We think the actual exchange rate is as cheap relative to the economic fundamentals that drive exchange rates over the long term as we've ever seen over the last 35 years. So, a lot of this gloomy picture is baked in, we are not facing a big cliff edge in some domestic investments.

In the Budget, there were some positive things, but they are all relatively small. So, it was great that we are seeing an increase in the tax credit for research and development, that’s really important to attract business investment particularly in the Brexit environment. Because we know that a lot of business investment is intended to be allocated towards R&D over the next few years.

Wall: Ed, thank you very much.

Smith: Thank you.

Wall: This is Emma Wall from Morningstar. Thank you for watching. 

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Emma Wall  is former Senior International Editor for Morningstar

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