British Budget Highlights and Thoughts

March 23, 2011

Chancellor of the Exchequer George Osborne did not flinch from the deep deficit-reducing fiscal strategy adopted last year in spite of last quarter’s unexpected investment-led drop in real GDP, a rise in unemployment to 8%, and the weakest consumer confidence in some two years. 

The main headline to emerge from Osborne’s second budget address, a downward revision of 0.4 percentage points in projected real GDP in 2011 to 1.7%, is less striking than the news reports imply.  1.7% is in line with current private-sector forecasts for both the U.K. and the euro area this year and only moderately weaker than what analysts were projecting a year ago before the Conservatives came to power and changed the direction of fiscal policy. 

If anything, Osborne’s growth forecasts beyond this year of 2.5% in 2012 and 2.9% thereafter look too optimistic.  Austerity is to be maintained for several years, as attested by targeted public-sector borrowing of GBP 122 billion in 2011/12 after GBP 146 billion this year, then GBP 101 billion in 2012/13, GBP 70 in 2013/14, GBP 46 billion in 2014/15 and GBP 29 billion in 2015/16.  At some point and probably sooner than later, pressure on prices are likely to force the Bank of England’s hand on raising interest rates.  Osborne’s budget projects CPI inflation next year at 2.5%, down from a probable monthly peak sometime in 2011 that exceeds 5.0%.

Osborne’s strategy, like Canada’s announced yesterday, aims to close many tax loopholes and other means of stimulus.  But corporate taxation will be reduced progressively to 23% in around four years, giving Britain the G7’s lowest such rate.  Over 300K job cuts in the public sector during the next four years will need to be absorbed by the private sector.  That possibility seems too ambitious.

The tough love fiscal approach has multiple objectives.  One is to avoid a bond market meltdown as occurred in Euroland peripheral economies like Greece and Ireland.  It takes deep deficit cuts to stop the recently rapid growth of Britain’s debt/GDP ratio, which is hovering now at 58% and slated to climb another 13 percentage points before cresting even with if the Conservative’s austerity medicine is fully administered.  One can never be sure if or when that would happen because such is the road British officials have chosen not to follow.  All one can say is that In the United States, which like Britain saw its fiscal deficit soar above 10% during the recession and where the government is not pursuing immediate severe fiscal restraint, ten-year bond yields remain historically low and around 25 basis points lower than British yields.  Moreover, British growth is considerably weaker than U.S. growth.

It is also claimed that tough love now will enable stronger sustainable future growth.  Britain’s trade position failed to benefit as much as hoped from earlier depreciation of the exchange rate, and continental Europe’s own economic difficulties will limit the scope for export-led support while domestic austerity is imposed.  Sterling had performed very poorly in late 2008 and 2009.  Since early February of this year, however, cable has been stronger than $1.60 after trading in a 1.4232 to 1.6457 range against the dollar in 2010 and to as low as $1.3505 in 2009.  It seems doubtful that a return to near-3% GDP sustainable growth can be secured by 2013.  The ultimate judge of Osborne’s fiscal policy will be told by whether this can in fact be done and by whether the deficit/GDP and debt/GDP ratios adhere to their projected trajectories.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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