Fishburn Hedges

10.03.2011

Summary

• The Budget will be something of a sideshow this year, overshadowed by the imminent and severe spending cuts starting in April.

• The Chancellor needs to regain the agenda, after a series of Coalition U-turns and wobbles on specific cuts.

• Growth over 2010 likely to be revised down from 1.8%, after a disappointing Q4. Total 2010/11 deficit will be a bit lower, after better tax receipts in Jan.

• Osborne is facing the triple whammy prospect of rising prices, unemployment and interest rates. His pro-growth package may not be enough to convince business or voters.

The Coalition has so far been defined by its aggressive deficit reduction plan, unveiled in last autumn’s Spending Review. Most voters have bought the Coalition’s argument that, overall, spending cuts are necessary. But the real cuts haven’t even started yet – apart from the £6bn emergency cuts made since last summer. And already, the Coalition has started to wobble, making a series of U-turns on forests, school sports and housing benefit.

Perhaps the biggest headache facing the Chancellor is the combination of stagnant growth and rising inflation. After a disappointing fourth quarter last year, overall growth for 2010 is likely to be revised down from 1.8% - and growth this year will struggle to exceed 2%.

Already double the Bank’s 2% target, inflation is set to rise above 4% this year - bumped up by the new 20% VAT rate and by rising food and oil prices. Interest rates - fixed at 0.5% for two years - are likely to rise around the middle of this year. The prospect of even slightly higher borrowing costs could hurt homeowners and consumers, and threaten to slow down the fragile recovery.

The Chancellor will want his Budget on 23 March to be a turning point, a Budget to remember – like Howe’s 1981 and Lawson’s 1986 Budgets. He needs to steady the Coalition’s nerves, after a difficult few weeks. He will also need to reassure voters and business that he isn’t just a cutter.

Having set out the big deficit reduction plan, Osborne is under real pressure to produce a convincing and compelling pro-growth strategy that will generate lots of new jobs. This pressure hasn’t just come from the Opposition and business leaders such as Richard Lambert, the former CBI chief. Plenty of voices inside the Conservative Party have been pushing Osborne hard, calling for a “supply-side revolution” and a programme of radical deregulation and tax reform.

At the Conservative Spring Forum last weekend, and in response to that internal pressure, Osborne billed his Budget “unashamedly pro-growth, pro-enterprise and pro-aspiration”. This is traditional Conservative territory, and a familiar Budget theme (one used repeatedly by Gordon Brown).

Decisions on the Budget are being taken not just by Osborne, but by the pivotal “Quadrilateral” of him, Cameron, Clegg and Danny Alexander. This is a far cry from the Gordon Brown way, which usually involved bouncing the Budget on Blair at the last minute. These days, the Treasury is transacting the Budget process in a much more orderly way – and Treasury officials seem to like it.

So what is the Budget growth package likely to contain?

• Growth Review: After the abortive Growth White Paper last autumn, Osborne will announce the initial findings of the Government’s Growth Review. This has been looking at issues such as competition, regulation and access to finance, in sectors including retail, construction, business and professional services, digital and healthcare.

• Fuel duty: Osborne has dropped a big hint that he will not implement the planned increase in fuel duty (1p above inflation) from this April. But given the continued instability in North Africa, fuel prices are set to increase further anyway.

• Enterprise Zones: Osborne has already announced plans for ten new Enterprise Zones, where business rates will be reduced and planning regulations simplified. But only £100m will be made available for these ten areas, over four years – not enough to trigger the growth that the whole economy needs.

• Deregulation: The Chancellor needs to move swiftly on this. Ministers have been operating a “one-in, one-out” system since September, where any new regulation is meant to be balanced by removing one of similar cost. But the British Chambers of Commerce and other business leaders are not yet convinced this is working.

• Bank lending: He will no doubt revisit Project Merlin, and challenge the banks to do more to lend to small businesses – particularly Lloyds and RBS. 

• Corporate tax: As well as plans to reduce corporation tax from 28p to 24p over four years, Osborne will report on how the Office of Tax Simplification is tackling the complexity of the current tax system. He might also expand on the Coalition’s long-term corporate tax strategy, set out last autumn.

• Local government finance: He may announce the formal launch of the Local Government Resource Review, which will aim to incentivise local councils to go for growth by allowing them to retain business rates. This is tricky territory, but Eric Pickles and Treasury Ministers are determined to press ahead.

• Savings: He could make some kind of announcement to encourage savings. Leading voices like Andrew Tyrie (Chair, Treasury Committee) have been pushing for this – so look out for enhanced ISAs, or similar.

One thing that the Chancellor definitely won’t do…Conservative MPs are pressing Osborne to reduce the 50% top rate of income tax. He’s already signalled that 50% is not permanent – but it’s politically impossible to reduce any time soon.

So, will this Budget be the turning point that Osborne wants, or a sideshow?

Longer term, the economy is set to rebound in time for the 2015 election – more due to the long-run cycle, than any particular policy. But Osborne will want to claim credit for the rebound, so is positioning this Budget as the critical turning point. The more active the Budget is on growth, the more credit he will be able to claim. 

But the biggest announcements, on tax and spending, have already been made. With VAT already at 20%, the first year of deep spending cuts starting in early April, bank lending still constrained and few concrete pre-growth ideas on the table, the Budget could be seen as a damp squib.

Meanwhile, the deficit reduction plan needs to be delivered over the next four years. This is the critical and central task for the Coalition. If the planned spending cuts are not implemented in full – and recent wobbles suggest they may not be – further tax rises will be needed. That presents voters and business with a dilemma – squeal too much about the spending cuts, and they could find themselves paying even higher taxes later on this Parliament.

OBR Budget forecast

The Office for Budget Responsibility will publish its latest forecasts on Budget Day. Here’s a quick snapshot of the OBR’s current forecast and its likely revisions.

Growth

The OBR is currently forecasting +2% growth over 2011/12, after the UK economy shrank by 5.0% in 2009. So, no double dip recession. But the OBR will probably need to revise 2010 growth down from 1.8%, because the economy shrank in the fourth quarter of 2010 by minus 0.6% (way below the forecast growth of +0.5%).

Most indicators point to positive growth in the first quarter of this year, with stronger retail sales in January and healthy manufacturing growth. But the rest of this year could see subdued growth of no more than 2%. Retail sales in February were the worst in two years.

Deficit

The deficit (public sector net borrowing) is due to fall from £148.5bn in 2010/11 to £117bn in 2011/12, and eventually to £18bn by 2015/16. That overall picture will remain roughly the same – but total borrowing for 2010/11 will be a few billion lower than £148bn, due to higher than expected tax receipts in January.

From April, departmental budgets (other than health and overseas aid) are due to be cut by an average of 19% over the next four years. For local government, it’s even worse (27%).

Jobs

Employment is set to grow from 29m in 2010 to 30m by 2015. The OBR forecast in November that unemployment will peak at 8.0% this year to 6.1% by 2015. But, given recent labour market worsening, unemployment is likely to peak higher than 8.0% this year.