UK Economy to Slow Further, According to the OBR, but Others Say this is too Pessimistic

The UK economy faces multiple headwinds to growth over the coming years, according to the OBR, although some think its forecasts might be a little too pessimistic. 

The outlook for the UK economy in 2018 and beyond appears grim, based on the latest round of forecasts from the Office for Budget Responsibility, suggesting the small boost in growth momentum seen during the third-quarter could soon begin to wane.

Britain’s economy is on course to expand by around 1.5% for the 2017 year, a much lesser rate than the 1.8% seen in 2016, following a slowdown during the first-half. This marks a downgrade on the OBR’s March forecast for the economy to grow by 2% in the current year.

“The difference appears mainly to reflect a deceleration in real consumer spending as higher inflation following the depreciation of the pound squeezed real household incomes,” the OBR says in its latest statement.

The OBR forecasts the economy will maintain its current rate of growth in the final quarter but the quarterly pace of expansion will fall back to 0.3% early in the New Year.

“Beyond 2018, we expect GDP growth initially to remain a little below potential,” the OBR says. “The continued weakness reflects the forthcoming fiscal tightening (notwithstanding the Budget measures) and uncertainty surrounding Brexit continuing to weigh on business investment.”

In the years to the end of 2021, UK economic growth is seen averaging 1.4%, reflecting sharp falls in consumer spending, reduced household investment in dwellings and sclerotic government spending over the forecast period. Net trade is also seen adding very little to growth over the period.

“The depreciation of sterling since late 2015 has been substantial, but we judge that the total boost to net trade will nevertheless be relatively modest in historical terms,” says the OBR. ”So far, the judgement of even a modest boost to net trade has proved to be on the optimistic side.”

At the time of writing, the Pound is more than 11% lower against the Dollar than it was on the night of the referendum, although it has been more than 20% within the last year. That fall had been expected to lift net trade although, given the increased cost of imports, the overall balance has barely budged so far to date.

“GDP growth is expected to pick up a little from 2021, as the effects of the fiscal consolidation subside and the uncertainty surrounding Brexit is assumed to dissipate,” says the OBR. “Faster productivity growth also begets a modest acceleration in real wages and consumption.”

Adding to the gloom, the OBR also cut its productivity growth forecasts Wednesday, which bodes ill for those hoping to see a pickup in wages. Productivity growth, or an increase in the amount produced by the average worker in each hour, is seen as essential to an eventual pickup in wage growth. 

The latest OBR forecasts come alongside the Chancellor’s autumn budget statement, which saw Chancellor announce a fiscal giveaway of close to £10 billion per year between 2019 and 2020.

"Downward revisions to productivity growth and a slight easing of austerity by Hammond combined to offset the better starting point for the public finances. Cyclically adjusted PSNB as a share of GDP was revised down to 2.4% in this fiscal year," says Oliver Harvey, a macro strategist with Deutsche Bank. 

A reclassification of housing association debt makes the giveaway's impact on the public finances largely neutral as, on current projections, the government is likely to meet its target to reduce the budget deficit to 2% of GDP by 2020-2021.

"The net effect of the changes has been to ease back on the pace of austerity over the coming years, with the fiscal stance now tightening by less than 0.5% of GDP next year and even less in the outer years of the forecast," says Jonathan Loynes, chief economist at Capital Economics.

Increased government spending, or a reduced focus on austerity, may lend some support to the economy over the forecast horizon as the UK exits the European Union.

“And if we are right in thinking that the OBR has now become too gloomy about productivity and growth prospects, this could give the Chancellor rather more elbow room in the coming years than the current projections suggest,” adds Loynes.

Loynes and the Capital Economics team are not the only forecasters who say the OBR could be a slight bit too pessimistic in its outlook for the economy.

“Relative to both ours and the BoE’s forecasts for real GDP growth, the OBR is lower by an average of 0.3pts per year to 2020,” says Kallum Pickering, a senior UK economist at Berenberg. “It is possible that, after consistently overestimating the UK’s growth prospects in the past, the OBR have gone a little too far with the downgrades this time around.”

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