So, the OBR has now slashed it’s UK growth forecast for the rest of this year in half (Source: OBR: Economic and fiscal outlook – March 2025) with it now forecasting just 1%. But with the UK economy undergoing a tricky time, particularly given the huge global uncertainty, Laith Khalaf, head of investment analysis at AJ Bell, has been digesting the details of the Spring Statement and the OBR report as he shares with us in the following analysis:
“The world might have changed but it feels like more of the same for the UK economy. Low productivity, tight public finances and a historically high tax burden are morbidly familiar themes for the OBR forecasts to showcase. The chancellor pulled the tax lever hard last October to meet her own self-imposed fiscal rules, and this time around, it’s spending which is in the firing line to balance the hole in the books created by shifting macro-economic factors, most notably interest rates and inflation expectations.
“Rachel Reeves has chosen to restore her headroom but unfortunately this is still a relatively small buffer which leaves the public finances vulnerable to small corrections in the forecast. Hence why the OBR assigns just a 51% chance to meeting the debt target and a 54% chance to meeting the current budget target. In other words, despite spending cuts, it’s still a coin toss whether the chancellor will meet her own fiscal rules or not. If real economic data points fail to match up with the OBR’s predictions between now and the Autumn Budget, you can be sure that will fuel further speculation on more tax rises to come.”
Data points to watch
“There are number of key macro-economic data points we can keep an eye on in the next six months which will provide some insight into whether some more fiscal hole filling will be required in the Autumn Budget. Interest rates and gilt yields are a key factor in meeting the fiscal rules because they determine the cost of servicing government debt. If rates and yields move just 0.6% higher, that will remove the chancellor’s headroom entirely according to the OBR. To give some context, the benchmark 10 year gilt yield has moved up by 0.4% since the October Budget.
“Inflation is another factor which may weigh heavily on the fiscal situation. It does this directly, by increasing the cost of index-linked gilts, and indirectly, by keeping interest rates higher. Like the Bank of England, the OBR expects inflation to peak at 3.8% later this year before falling back towards the 2% target. However this is predicated on forecasts for food and energy prices, two notoriously unpredictable factors which are excluded from core CPI measures precisely because they are so volatile. Inflation does have an offsetting benefit for the fiscal picture because it can also raise tax revenues, especially in light of frozen income tax thresholds. Figures released by the OBR today show that they now reckon frozen tax thresholds will create 3.5 million new higher rate taxpayers, up from 3 million at the October budget, presumably because wage growth expectations have been nudged upwards and higher forecast inflation would have provided greater protection from tax if thresholds were indexed.
“One of the key judgements made by the OBR is its productivity growth forecast, which the watchdog admits is highly uncertain, and which can lead to big swings in the government’s balance sheet. The OBR currently estimates productivity growth will be 1% a year over the forecast period. If the data fails to support this forecast, or the OBR changes its view by the time of the Budget, this measure could make a big difference to the fiscal picture and consequently government tax policy.”
Fiscal rules – what are they good for?
“Rachel Reeves has gone to great lengths to prove she is fiscally prudent, no doubt a millstone which hangs heavier around the neck of a Labour chancellor. Some will say the chancellor is creating a rod for her own back to the extent that she has formulated the fiscal rules to which she must now submit. As long as we have fiscal rules, there will be a question mark over whether they are fit for purpose, but undoubtedly some constraint and guidance on borrowing is required.
“Playing fast and loose with the support of government bond investors is no free lunch, as Liz Truss found out to her cost. Higher government debt ratios make investors twitchy, and more gilt issuance requires greater demand to materialise if it’s not to push up the cost of government borrowing, which of course acts as further unwanted pressure on the public finances. By the same token we shouldn’t pretend our bond market is an island. Global capital can flow across borders, and so developments in the US or in European bond markets can easily prompt significant movements in gilt yields, as we have seen this year.
“Given all the factors outside the chancellor’s control, she may rue missing the opportunity to make the fiscal framework more chaise longue and less iron chair. In particular having one fiscal event every year but two OBR forecasts simply isn’t politically plausible. It would require the chancellor to stand up in parliament, state that she isn’t meeting her fiscal rules, but that she’s not going to do anything about it for six months. The desire to reduce policy volatility is absolutely commendable, to which end it would make some sense to wheel out the OBR’s fiscal forecasts just once a year in line with the Budget. Otherwise we may easily fall back into the rhythm of two fiscal events every year. Another option would be to adjust the fiscal rules to allow for some margin of error at interim forecasts, so policy action is only required if there is a significant deviation from target. Clearly this Spring Statement isn’t as fulsome as a Budget, but there are still meaningful policy changes which might have been avoided if the chancellor wasn’t obliged to publish the betting odds at half time.”
