IN RECENT weeks the Prime Minister and Chancellor have made clear their determination to stick with “Plan A” and reject calls for any loosening of the deficit reduction strategy.
This has served to dampen speculation that the Chancellor’s autumn statement, due on 29 November, will see any significant change to the course the government has set.
But this day will also see the publication of the latest forecasts from the Office for Budget Responsibility (OBR). These will cover economic growth, the budget deficit and inflation. The growth forecast will almost certainly be sharply downgraded, while the deficit forecast is likely to see significant slippage from the target set in the Budget. The 2012 growth forecast in particular, currently 2.5 per cent, may be cut to just 1 per cent or lower. This will be especially uncomfortable given the backcloth of rising unemployment, and the growing political outcry over the level of youth unemployment in particular.
For that reason it will be difficult for the government to be seen to be presiding over a marked slowdown in the economy with a policy of no change. The status quo in political terms may well become an untenable option.
The collapse in growth forecasts by the Bank of England’s Monetary Policy Committee gives some measure of the discomfort ahead. At the end of last year, the Bank’s inflation report predicted that economic growth this year would be 2.6 per cent, followed by 3.3 per cent growth in 2012.
Its most recent report, in August, estimated growth of just 1.5 per cent this year and 2.2 per cent next. But that is by no means the end of the downgrades.
Prospects have since deteriorated further. In the wake of figures last week showing UK industrial output was down 1 per cent year-on-year in August – the sixth consecutive month of stagnation or decline – the Centre for Economics and Business Research (CEBR) has cut its forecast for 2011 from the 1-1.5 per cent range to 0.6 per cent, with growth in 2012 pared back to 0.7 per cent.
The growth slowdown is already hitting the deficit reduction programme. For 2011-12, the budget deficit target is £121.8 billion. To meet this, government revenues need to rise by 6.9 per cent. In the five months April-August, the rise was just 4.6 per cent. Spending, meanwhile, continues to rise and is up 3.7 per cent on a year ago.
Two factors in particular have brought us to the brink of recession. The first is the financial crisis in the Eurozone and the effect this is having on business and household confidence. The second is the intensifying squeeze on household spending resulting from the combination of low income growth and high inflation.
One aspect of last week’s labour market data – the figures on average earnings – was lost from view, given the coverage on youth unemployment. The annual growth rate for regular pay (excluding bonuses) stood at just 1.8 per cent for the three months to August. This is less than half of typical pre-recession levels and continues to trail behind consumer price inflation at 4.5 per cent. This shows starkly the squeeze on incomes now being felt and explains why consumer spending – a key economic driver – has now fallen for four consecutive quarters.
Household spending in the three months to June was just 0.1 per cent higher than in the trough of recession. For this, above-target inflation has much to answer for. The one pinprick of light in what is set to be a sombre set of forecasts from the OBR is that inflation may be lower this year as the pre-VAT rise falls out of the 12-month comparison.
But now the Bank has launched a further bout of monetary expansion, or quantitative easing (QE) – £75bn to start with, and which could rise to £300bn in due course. One of the concerns over QE is that it builds inflationary pressures. Asset prices are driven higher without any compensating rise in incomes. And it also works to lower the pound, driving up the cost of raw materials and imported goods.
This does not augur well for household budgets and suggests that the spending squeeze will continue. And as long as it does so, growth prospects will be slim.
Fresh forecasts from the OBR are thus likely to unleash intense questioning over the government’s strategy and open it to the charge that conditions have changed so markedly for the worse since it was drawn up, it has now become self-defeating.
The Chancellor’s task is unenviable: how to improve prospects for growth in the immediate period ahead without opening himself to the charge that he is going back on his declarations of recent weeks, with the risk of triggering a loss of market confidence in the government’s strategy and in UK government debt.
A paper just out from economist Ryan Bourne at the Centre for Policy Studies entitled “Adrenalin Now – Funded, Popular Tax Cuts to Boost the Economy” suggests a way forward: targeted tax cuts funded by reductions in spending elsewhere, thus keeping the strategy intact.
The savings proposals will rouse ire, though far less than any reductions in welfare spending. These include the abolition of differential rates of pension tax relief for higher-rate taxpayers (raising £7bn), the abolition of contracting out of the state earnings-related pension (£3.5bn), pegging international aid to 2010-11 levels of spending (£1.3bn) and ending the 25 per cent tax-free lump sum entitlement from pensions (£2.5bn).
This, he argues, would yield sufficient savings to fund a reduction in employers’ National Insurance contributions to 12 per cent; granting a National Insurance contribution holiday to small firms (up to four employees) for two years; cutting Corporation Tax by four percentage points to 21 per cent by 2012-13; and increasing the income tax personal allowance by £500 more than planned to £8,605 for 2012-13.
This would at once help lower-income families and take thousands out of tax altogether. Such measures would give a more immediate boost to household incomes, confidence and spending than government infrastructure projects.
Were the Chancellor to indicate that such measures were being considered for inclusion in the 2012-13 Budget, he might be able to take the sting out of political attacks while at the same time keeping the deficit reduction strategy intact.