THE pressure on the UK economy has not been as great since the financial crisis of 2008. The impact of a disorderly Brexit process was bad enough. Then came Covid-19. The challenge for policy-makers could barely be greater. The UK’s Central Bank is of course independent of Government. But they nonetheless acted on Budget day to provide practical and sentimental support for markets and the real economy in an impressive show of tacit co-ordination.
The day began with an impressive and co-ordinated intervention from the three-policy committees of the Bank of England. Given the firepower at their disposal, they provided what monetary stimulus they could in the face of the economic risks from coronavirus:
- The Monetary Policy Committee provided an emergency cut in the Bank Rate to 0.25bp, and ...
- ... an injection of support for bank lending to SMEs of an estimated impact of £100bn;
- The Financial Policy Committee reduced the UK counter cyclical capital buffer rate to 0% from 1% (rising previously to 2% by December). This reduces the extra safety element of capital that banks are required to hold and not lend to allow more cash to flow into the economy – up to £190bn;
- The Prudential Regulation Authority set out a “supervisory expectation” (that is the threat of a raised eyebrow) that banks should not increase dividends (returns to shareholders) or other distributions such as bonuses to executives. This is their way of ensuring that public policy support does not lead to a direct return to the recipients’ executives and investors but rather reach the “real economy”.
The transmission of the Bank Rate cut to the economy both takes time and at such low levels is difficult to be sure of. The injection of up to around £300bn of extra bank lending resource should, at the very least, help correct for a growth in risk aversion by the banks. This looks to me like an attempt to correct a negative as much as a positive injection of resource.
Then came the Budget from new Chancellor Rishi Sunak. In the teeth of the global financial crisis in 2018, the combination of autumn and spring pre-Budget and Budget (as was) injected a combined £21bn of fiscal stimulus to the UK economy with a myriad of measures led by a cut in VAT. The scope for the Chancellor to beat that is best summed up in the chart opposite.
This shows that for long-term sovereign borrowing, money has never been cheaper. Outstripped by inflation, it effectively means that it is better than “free” for the UK Government to borrow right now.
With scope within fiscal targets to borrow more available, the temptation must have been to forget those targets for now. One of the lessons most economists take from the austerity budgets of the Conservative governments is that fixing the roof in a storm was not a good idea. The strictures became self-defeating as they reinforced sub-trend growth and therefore hit revenues and expenditure in the opposite direction. In short, austerity doesn’t work and is self-defeating.
The top-line fiscal injections announced yesterday were £176bn over the coming five years. That is a very substantial loosening and, the Chancellor told us, the Office for Budget Responsibility described it as the largest fiscal boost in nearly 30 years, since Norman Lamont’s pre-election giveaway.
Will this work? Well that is a question that economists have been debating since Maynard Keynes was a boy and before. If the injection turns out to be steroids it could still be worth it if it helps keep businesses and people afloat in the storm. If it helps invest in the economic muscle the economy requires, all the better as the longer-term productivity performance could be enhanced.
Looking to the growth forecasts of the OBR in the table, from their outlook we do see a filip in growth in GDP from 1.1% this year to 1.8% in 2021, before drifting back to 1.4% by 2024. By comparison. the UK’s average growth rate over the last quarter-century was around 2%.
It is striking – and fundamentally disturbing – that net trade is set to have a negative effect on growth in the next five years. Business investment will make zero contribution this year and very little in the subsequent five. The whole source of the UK’s tepid growth will be government spending and investment and consumption.
The lesson of economic history is that this may see us through the storm but will do very little to boost the competitiveness of the economy longer term. But it is easy to be a critic. The quality of the eventual deal the Government strikes to actually “get Brexit done” will be far more important than the headlines on today’s events. The road ahead for the UK is a long one.
Two areas for a closer look
TWO final watch-outs from me for Scotland. The first is that the scale of the spending injection, more than £203bn in five years, is substantial. However, the knock-on Barnett consequentials for the Scottish Parliament are a tiny fraction of that.
This could be because many spending items are genuinely in fully reserved areas. However, I think it would be a very good use of Holyrood’s Finance Committee to ensure that the formula is not being by-passed deliberately. All the parties should be behind the Parliament interest on that.
The second is that the flexibility offered by proper borrowing powers is obvious. The Scottish Parliament’s flexibility and scope for borrowing for investment are very small comparatively. Once again, all of the parties should be able to agree that the financial powers need enhanced to include the ability to access low-cost borrowing on a much larger scale than at present.
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