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Economy doing better than expected, says OBR

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The Chancellor’s ‘Budget for long-term growth’ recognises inflation battle is not yet over – as OBR says that the economy is doing better than expected but we are entering a period of stagnating output.

6th Mar 2024
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In his Spring Budget speech, Jeremy Hunt said he had set out a plan to deliver long-term growth for the UK that will build a high-wage, high-skill economy with a path to more investment, more jobs, more productive public services and lower taxes.

However, given the limited fiscal headroom shown through the Office of Budget Responsibility’s (OBR) economic report, the Chancellor’s plans for a pre-election Budget tax giveaway had to be somewhat reined in.

According to the OBR, the Chancellor had financial headroom of around £9bn (back in November, he had £13bn), which the OBR said was “a tiny fraction of the risks around any forecast”.

Twin global shocks

The OBR report said the economy “has emerged from the twin global shocks of the pandemic and Russian invasion of Ukraine into a period of declining inflation but stagnating output”.

With inflation receding more quickly than expected in November and markets expecting a sharper decline in interest rates, this “should enable a faster recovery in living standards from last financial year’s record decline. But the medium-term economic outlook remains challenging,” it said.

When summarising the UK economy, the OBR’s report takes into account the changes made to national spending and the tax system in the accompanying Spring Budget.

The OBR’s report shows that – four years on from when the World Health Organization declared Covid-19 a global pandemic – a cohesive plan to get back to growth is sorely needed. GDP grew by just 0.1% in 2023, and the OBR expects the economy to grow by 0.8% in 2024 as interest rates fall and real household incomes recover. For 2025, GDP is forecast to rise by 1.9%, 2.2% in 2026, 1.8% in 2027, and 1.7% in 2028.

At the Autumn Statement, the OBR said growth was expected at 0.7% in 2024, 1.4% in 2025, and 1.9% in 2026, meaning the expected GDP growth for the next three years has been upgraded.

In its report today, the OBR said: “Risks to our medium-term real GDP forecast remain elevated. The outlook for productivity growth is our most important and uncertain forecast judgment, and there is significant uncertainty over both our migration and participation forecasts.”

It forecasts that underlying debt will rise from 89% of GDP this year to peak at 93.2% in 2027/28 and then fall slightly to 92.9% in the target year of 2028/29.

Living standards back to pre-pandemic levels by 2025

In November, the OBR forecast that living standards, as measured by real household disposable income (RHDI) per person, would fall by 1.5% in 2024, and then increase by an average of 1.5% between 2025 and 2028.

Today is said that living standards are now expected to recover more quickly than previously forecast and grow by around 1% a year on average, and it now expects real household disposable income per person to recover its pre-pandemic peak by 2025/26, two years earlier than in the November forecast. 

“The 2p cut to the main rates of NICs announced in this Budget alone is expected to directly boost real household incomes by 0.5%. This adds to a boost of similar size from the NICs cut announced in the Autumn Statement,” the report said.

Unemployment is now expected to peak at 4.5% (representing 1.6m people) in the last quarter of 2024, as the OBR forecasts subdued economic growth and increasing spare capacity in the economy. It is then forecast to decline to 4.1% by 2028.

The backdrop of recession and inflation

The UK economy went into recession at the end of 2023 after shrinking for two three-month periods in a row. However, Bank of England governor Andrew Bailey said the recession may already be over.

Even if the economy is now growing, many households are still struggling financially after two years of rising prices.

The pandemic, which caused supply chain disruption coupled with strong global demand for consumer goods, was not the only cause of inflation. 

Food and energy prices rose sharply during 2022 and 2023 due to global supply chain disruptions, and the effects of Russia’s invasion of Ukraine lifted the input costs of food producers. These pressures eased during the second half of 2023 and in early 2024.

The cost of living increased sharply across the UK during 2021 and 2022, with the annual rate of inflation peaking at 11.1%, a 41-year high, in October 2022. 

Inflation rate to fall more gradually in 2024

Annual inflation is currently at 4%, unchanged since December. Inflation is expected to continue to fall in 2024, though more gradually than in 2023, due to lower energy prices and reduced inflation in consumer goods and food.

In forecasts published alongside the Spring Budget, the OBR expects inflation to average 1.4% in Q4 2024. 

The Chancellor today said that debt is on track to fall, although he admitted that “the battle against inflation is still not over”.

He said: “Of course, interest rates remain high as we bring down inflation. But because of the progress we’ve made, because we are delivering on the prime minister’s economic priorities, we can now help families not just with temporary cost of living support but with permanent cuts in taxation.

“We do this to give much-needed support in challenging times because Conservatives know lower tax means higher growth. And higher growth means more opportunity, more prosperity, and more funding or precious public services.”

He added: “With the pandemic behind us, we must once again be responsible and build up our resilience to future shocks. That means bringing down borrowing so we can start to reduce our debt.”

Interest rates expected to come down

To try and get the inflation rate back to its 2% target, the Bank of England (BoE) increased interest rates at 14 consecutive policy meetings from 0.1% in December 2021 to 5.25% in August 2023, and they have remained unchanged since.

Pressure is now on the central bank to cut interest rates. However, February’s monetary report said that as a result of inflation persistence, the "monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term", and a cut is not likely to happen at the next announcement on 21 March.

Andrew Bailey, the BoE’s governor, has repeatedly said rates will remain as they are for some time, but economists and the financial markets are expecting a change in approach by June. The OBR confirmed that it expects to see the Bank Rate fall to 4.2% in the final quarter of 2024 in order to help stimulate economic growth.

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