Ensuring the medium- to long-term sustainability of the UK’s public finances appears more challenging following the November Budget and the Office for Budget Responsibility’s (OBR) reduction to its economic growth forecasts, Fitch Ratings says.
The OBR now expects real GDP growth to average 1.4% over the four years to 2020, down from 1.8% in its March forecasts, before picking up slightly to 1.5% in 2021. This would leave the level of real GDP in 2021 around 2% lower than forecast in March. The revision is largely due to a weaker productivity assumption, which also means the OBR’s assumptions for potential growth have come down significantly (now averaging 1.4% to 2021). Weaker growth makes reducing public sector indebtedness more challenging.
We expect the UK economy to expand by 1.3% next year, but are more optimistic than the OBR for 2019. Nevertheless, as we said when we affirmed the UK’s ‘AA’/Negative sovereign rating last month, our projections for 2019 are unusually uncertain, as macroeconomic developments will be related to the outcome of the Brexit negotiations.
The outcome of the June general election suggested that ‘austerity fatigue’ is a meaningful factor in British politics and the Budget included discretionary fiscal measures that will translate to a fiscal policy loosening of GBP16 billion in the next two financial years (around 0.3% of GDP in FY18/19 and 0.5% the following year).
The main changes on the tax side are the abolition of stamp duty for first-time home buyers for the first GBP300,000 on a purchase up to GBP500,000, and the freezing of fuel and alcohol duties. The main spending change is extra current and capital spending on the National Health Service of around GBP5 billion over the next three financial years.
The OBR still expects the public sector deficit to fall, but probably not fast enough to meet the government’s target of a balanced budget by the middle of the next decade. The structural deficit would still fall below the government’s 2% of GDP target of in FY20/21, but with a smaller safety margin than forecast six months ago.
The OBR now expects the public debt ratio to decline only slightly over the next three financial years. This underlines the scale of the challenge of putting the UK public debt ratio on a firm downward path.
Our deficit projections from our October rating review, which do not incorporate the latest policy announcements, imply general government debt declining gradually as a share of GDP from a peak of 88.3% of GDP in 2016 to 85.7% of GDP by 2019. This would still leave the UK with one of the highest public debt ratios among highly rated sovereigns. If we mechanically feed the discretionary policy changes in the Budget into our October public finance projections, this also suggests slightly worse public debt dynamics over the next few years.
