First reflections on the Budget

There were no major surprises in the Budget today, with many of the announcements broadly expected. The main rate of corporation tax, which has already been reduced from 28% to 26%, will fall to 24% in April and will be reduced to 22% over the following two years.  The reduction in corporation tax will be funded by a further increase in the Bank levy. Duty on tobacco will increase by 5% above inflation (equivalent to 37p a packet). The fuel escalator will only be reintroduced if oil prices fall below c$75/barrel. Stamp duty on residential properties held within corporate and overseas envelopes will be 15% with immediate effect and stamp duty land tax rate on residential properties worth more than £2m will increase to 7% with immediate effect. The 50p additional tax rate will be reduced to 45p from April 2013. Personal allowance will increase to £9,205 in April 2013.

There are winners and there are losers as there are with all Budgets, but stepping back to look at the big picture, the Budget was essentially fiscally neutral and the Office for Budget Responsibility (OBR) forecast that Mr Osborne has a greater than 50% chance of hitting his two fiscal targets – elimination of the structural deficit by 2016/17 and a decline in the net debt to GDP ratio by 2015-16.

Over the budget period, 2012-13 to 2016-17, the total fiscal squeeze (amount brought in by tax increases less amount spent) amounts to £0.6bn and from a purely spending-multiplier perspective this is not likely to have a substantial impact on economic activity, although the government will argue that the composition of tax reforms will stimulate growth.

Interestingly, Cyclically Adjusted Borrowing assumptions are largely unchanged with the slightly worse deficits resulting from the OBR’s revisions to the UK output gap. The alteration suggests that the UK is slightly less far from potential output than previously expected. This means that slightly more of the deficit is structural and there may greater risks of accelerating inflation than anticipated hitherto. That said, the revision is not as dramatic as that made in the OBR’s November publication, and probably does not indicate a major revision to the UK’s economic position.

In focus the Budget was not macroeconomic. Both fiscal and economic forecasts are broadly unchanged, with much of the changes focused on microeconomic issues such as optimal levels of tax and providing stimulus to certain industries. Microeconomic changes to taxes may ultimately have macroeconomic effects by encouraging investment and labour within the UK, although such outcomes are by their nature uncertain in scale and timing.

Importantly, the OBR’s downward revision to world and Euroland growth highlights the risk that external developments can affect the UK’s economic situation and securing the planned reduction in the budget deficit requires real UK GDP growth to increase to 2% in 2013, 2.7% in 2014 and 3% in each year thereafter.

Lowering the deficit over the medium term requires not just accelerating growth but also a sustained period of fiscal restraint and a prolonged period of low interest rates. However hopes of improving growth trends may not be too extravagant. Indeed, assuming a stable household saving ratio (of around 6½%), actual household discretionary spending may increase by as much as 7% in 2013, up from an estimated 2-3% increase in 2012, with an increased likelihood of a sustained pick up in consumption growth over the next 12-18 months. Consumption should be helped by falling inflation which eases the squeeze on real incomes, and beyond 2013, the OBR’s central forecast is for average earnings growth to be around 4½% per annum. With inflation forecast to remain steady at 2%, helped in part by an assumed fall in oil prices to $95/barrel by the end of the forecast horizon, growth in real household disposable income is projected to increase towards 2½%.

We may conclude that the risks to the projections in the OBR’s central case are skewed to the downside but even if growth were to be lower than assumed in the central case, the good news is that the underlying picture is likely to be one of sustained improvement in the government’s budgetary position, and the economy more generally. We may however begin to worry about longer term inflation risks.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla