Rock & Hard Place

The Christmas break marks the mid-point for this government and thus Chancellor Osborne is due a half-term report. The usual phrases about trying harder, could do better or has failed to live up to his early promise could all be used with a degree of truth but none would really tell the whole story or be fair to him.

Today, the interesting views of Dennis Turner, Economist.

Without doubt, he is missing his two key fiscal targets and the growth of the economy has been disappointing. It would be very harsh to claim, however, that this slippage on his objectives is the result of misguided Treasury policies. Rather, external events have conspired with fragile domestic conditions to produce the weakest recovery from recession in the UK since records began.

And it is not only the Chancellor who has got it wrong. For once, economists collectively have been guilty of an excess of optimism. For the last three or four years, growth expectations for the UK have been revised down as the year progresses and hopes for a return to business as usual have been disappointed. As ever, the reasons are obvious in retrospect. The consumer sector is still bruised by debt, squeezed by inflation and uncertain about job prospects, the cash-rich corporate sector lacks the confidence to invest while the turbulence in the Eurozone has choked off the most attractive escape route of exporting.

The Chancellor looks to the independent Office for Budget Responsibility for his short-term forecasts on which he bases his fiscal projections. The OBR forecasts are usually well within the consensus but, like everyone else, have generally come up short particularly in terms of growth. This clearly feeds back to Mr Osborne’s tax and spend numbers. If growth is slower than expected, tax receipts are lower, spending higher and the deficit wider. It has been claimed that he should have had growth as a bigger priority and been prepared to live with a bigger deficit for longer, thus providing the stimulus needed for recovery. But he, like financial markets, values the UK’s triple A credit rating, which has kept borrowing costs at historic lows, and at rates comparable with Germany.

At the halfway stage, his dilemma is clear. In Q3, GDP grew by around 1%, the fastest quarterly growth for five years. But tax revenues have been weak and the Treasury is likely to have to borrow £13 billion more in 2012-13 than was forecast in March’s Budget. The date at which the budget will be in balance has now been pushed back well into the next parliament and national debt will still be rising as a share of GDP at the time of the next election, both implying a failure of policy.

To make the fiscal numbers look more respectable, the Chancellor could cheat (hijack the £35 billion of interest in the Bank of England arising out of QE and include them in his figures) or shift policy away from his Plan A.

Although the Q3 was impressive, much of it was attributable to one-off factors and growth will not be sustained at this rate in the coming months. So, should Mr Osborne try to stimulate growth via government spending which could weaken his finances in the short-term and jeopardise the UK’s prized AAA rating or does he hope recovery has sufficient momentum and so stick to his deficit and debt reduction plans?

This is pretty much a political judgement, and it is a close call. If he does choose to give activity an extra push, he can take some comfort from the fact that since the Bank of England is such a large purchaser of gilts, the triple A might not be at risk. If he goes this route, more investment, which will probably mean construction, may help unlock the resources in the corporate sector. And this would be preferable to stimulating consumption through tax cuts, much of the benefit of which would leak overseas through imports. The choice is a difficult one, the fabled rock and a hard place, but in terms of outcomes, Mr Osborne must be hoping his time at the Treasury will be a game of two halves.

Duncan R Glassey
Senior Partner – Wealthflow LLP

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