InvestmentsDec 1 2015

Questions raised over OBR debt interest forecasts

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Questions raised over OBR debt interest forecasts

Economists have called into question the improved outlook for the UK’s public finances, noting forecasts by the Office for Budget Responsibility (OBR) depend on the Bank of England (BoE) taking a cautious line on interest rates.

The forecasts, released in the Spending Review and Autumn Statement last week, revealed a £27bn boost to public finances driven by improved tax receipts, lower inflation and expectations that government bond yields will stay lower for longer.

This gave chancellor George Osborne a chance to scrap his plans to cut tax credits, and meant the government remains on track to achieve a structural surplus by 2019/20.

However, Pantheon Macroeconomics played down the forecasts and said it doubted finances would heal that fast.

Its chief UK economist, Samuel Tombs, said: “The OBR continues to take an overly optimistic view on the fiscal squeeze’s impact on GDP growth, the likely yield from tax avoidance measures, the ability of government departments to implement severe cuts and the outlook for debt interest payments.

“If interest rates rise more quickly than markets currently anticipate, as we think likely, then debt interest payments will rise sharply. The OBR takes it as given that government spending as a share of GDP can be reduced to early 2000s levels. But the demographic pressures on public services are much greater now than back then.”

Other economists also highlighted the Bank of England’s role in aiding the economy – specifically the assumption, implicit in the OBR’s prediction of lower bond yields, that the central bank will not raise interest rates materially over the course of the current parliament.

In the light of the Autumn Statement, the Monetary Policy Committee clearly needs to tread carefully when it comes to raising interest rates, said Capital Economics’ Roger Bootle and Jonathan Loynes.

They added that 2016 would still represent a continuation of austerity, underlining the need for caution: “The bigger picture is that the economy still faces a big fiscal squeeze next year.

Accordingly, the [BoE] will be in no rush to tighten [monetary policy] soon or quickly. Policy will have to remain extremely accommodative over the coming years to offset the looming fiscal consolidation.”

The OBR’s revised GDP forecasts predict 2.4 per cent growth for 2016 and 2.5 per cent for 2017, with a structural surplus of 0.5 per cent by 2019/20. Public sector net borrowing is forecast to cease by 2020/21, with a £10.1bn cash surplus in 2021 and a £14.6bn surplus one year on.

The government now expects to spend £275bn on gross debt interest between the 2016/17 and 2020/21 tax years, compared to the £281bn predicted in the Summer Budget. This, combined with tax receipts of £872bn in 2020/21 (up from a previous estimate of £856bn, and almost £200bn higher than this year’s figure) led to the better-than-expected forecasts.

Jason Stather-Lodge of OCM Wealth Management said of the revisions: “Mr Osborne is being as lucky as [Gordon] Brown was in 1997.”

He suggested early action from the BoE would be unlikely to damage the UK’s position, as higher tax receipts would offset the impact of rising borrowing costs. “If the BoE has to hike rates faster than expected, it will follow greater-than-anticipated growth so, in the short term, it will increase revenue,” he said.