Autumn Budget 2018: Background briefing

Economic situation

Economic growth recovered over the summer following a below-par start to the year. Severe winter weather had resulted in lower construction sector output and weaker retail sales, while the hot summer weather was a factor in the growth rebound.

The underlying economic performance is less positive – annual GDP growth rates of between 1% and 1.5% remain below those of recent years and lower than in many other large advanced economies.

Recent economic growth mostly reflects the subdued performance of consumer spending, traditionally the main driver of UK economic activity. The squeeze in household budgets following last year’s rise in inflation, principally due to the fall in the pound after the EU referendum, continues to dampen the spending outlook.

Other parts of the economy are not providing much support to growth, with investment stalling and export growth slowing sharply in 2018 after a robust performance in 2017.

Tentative signs of accelerating wage growth in recent months, combined with forecasts of lower inflation heading into 2019, could boost household incomes. The labour market remains strong with the unemployment rate at a 40+-year low and the proportion of the working-age population in work near record highs.

The outlook is marked by uncertainty over Brexit negotiations. Most economic forecasts, including those of the Office for Budget Responsibility, are premised on a withdrawal deal between the UK and EU being agreed. This would result in a transition period after Brexit whereby the UK remains in the EU single market and customs union. Should the UK leave the EU without a deal, economic conditions may be very different, with the OBR warning that a disorderly Brexit “could have a severe short-term impact” on the economy.

Public finances

Borrowing and debt

Government borrowing – the difference between public spending and income raised from taxes and other sources – is at a relatively normal level, having decreased from the peaks reached following the financial crisis. At 1.9% of GDP, borrowing in 2017/18 was below the average for the past 70 years. The OBR expects borrowing to fall further over the next five years, largely from government controls over day-to-day public spending.

Borrowing over the first half of 2018/19 has been lower than expected which may lead the OBR to lower its underlying borrowing forecast. If the OBR believes that some of the improvement in borrowing is permanent, and not due to temporary factors, it will also lower its forecast for future years.

While the situation for government borrowing looks positive, government debt – broadly speaking, the stock of past borrowing – remains high at 85% of GDP. The debt-to-GDP ratio was last above 85% in the mid-to-late 1960s, when it was still recovering from reaching over 200% of GDP during World War II. The OBR has forecast gradual falls in the debt-to-GDP ratio over the coming years, but by 2022/23 it expects the debt-to-GDP ratio to still be not far under 80%.

The OBR’s forecasts assume that Brexit negotiations lead to an orderly transition to a new long-term relationship with the EU. A less orderly outcome will likely have a negative impact on the public finances.

Public spending plans

In the Budget, the Chancellor is expected to set out his plans for total public spending in 2020 and beyond. This spending will then be divided amongst departments at the 2019 Spending Review.

Current spending plans, pencilled in at Autumn Budget 2017, see total public spending increasing in real terms (ie adjusted for inflation) a little year-on-year until 2022/23.

However, not all areas of public spending are forecast to follow the same trend. While departments’ capital spending and demand-driven spending, such as welfare, are set to increase or remain flat, departments’ day-to-day spending on public services is forecast to decrease in most years to 2022/23.

In her recent speech to the Conservative Party Conference, the Prime Minister signalled that austerity is to be brought to an end, with details to be set out at the 2019 Spending Review. There is no single definition of austerity, but the term is often used to describe recent reductions in day-to-day spending on public services. The Chancellor will have to increase day-to-day spending, compared with current plans, to prevent future real terms (adjusted for inflation) falls in such spending. However, this may not be enough to end austerity on other definitions of the term.

If the Government were to accept that additional spending is required to end austerity, this may conflict with its targets for reducing and eventually eliminating the deficit, and its pledge to keep taxes as low as possible.

Developments since Spring Statement 2018

Since Spring Statement 2018, for the public finances the most significant Government announcement has been additional funding for NHS England. The NHS is to receive a funding increase worth around £20 billion in real terms by 2023/24 and the Chancellor is expected to set out how this will be paid for in the Budget. Respected think tanks are expecting the funding pledge to be met through a mix of borrowing and higher taxes. Indeed, both the Prime Minister and the Chancellor have hinted that the Budget is likely to feature some tax rises. However, it seems likely that the OBR will lower its underlying forecasts for borrowing, potentially giving the Chancellor more scope to borrow to fund the increased NHS spending.

In a move that will lower tax revenues by around £900 million, the Prime Minister announced that fuel duty will be frozen, for the ninth year, in April 2019.

Other things: Universal Credit

The Chancellor has been coming under pressure to provide additional funding for Universal Credit. As the roll-out of the new system – which is replacing means-tested benefits and tax credits for working-age households – continues, concerns have been raised about the substantial losses some families could experience on moving from legacy benefits to Universal Credit.

The Library will publish its summary of UK Economic Indicators before the Budget.

Look out for Autumn Budget 2018 related ‘Insights’ on the Library’s website.