The UK’s budget deficit is currently around 5 per cent but new forecasts from the Office for Budget Responsibility (OBR) project it to fall to 4 per cent in 2015-16, 2 per cent in the following year and 0.6 per cent the year after that under the Government’s spending plans.
In his final Budget before the 2015 general election, Osborne said: “In 2018-19, Britain will have a budget surplus of 0.2 per cent, followed by a forecast surplus of 0.3 per cent in 2019-20. We will also comfortably meet our fiscal mandate and Britain will be running a surplus for the first time in 18 years.”
Borrowing is expected to amount to £90.2bn this year, then fall over the following years to eventually reach an overall surplus of £5.2bn in 2018-19. This forecast led Osborne to declare: “Out of the red and into the black – Britain is back paying its way in the world.”
But Neil Woodford, manager of the £5bn CF Woodford Equity Income fund, says the Government needs to “get a reality check” if it thinks the country will move into a budget surplus this soon.
Woodford has believed for some time that central banks’ growth and inflation assumptions are “consistently too optimistic” and says this sentiment also applies to the OBR’s forecasts.
“The forecasts released by the OBR, and the views expressed by chancellor George Osborne in the Budget, are not consistent with our views at all,” he said.
“So although the claims of a return to a budget surplus by 2018/19 for the first time in 18 years will make great headlines – and may sound attractive to potential voters – we believe a dose of reality is required.”
Woodford cites the below graph, which shows the projected path of the budget deficit. This is according to OBR assumptions of real GDP growth of 2.3 to 2.4 per cent per annum over the next five years and inflation returning to the Bank of England target of 2 per cent by the end of the period.
However, it also shows the path of the deficit if adjusted for a different set of assumptions to the OBR’s. This suggests a very different outlook for the UK’s public finances, as the manager said: “Using realistic assumptions, the fiscal deficit does not magically disappear.”
OBR and adjusted paths of UK budget deficit
Source: Office of Budget Responsibility; The Lazarus Partnership; Woodford Investment Management
“You don’t have to flex these assumptions very much at all to get a glimpse of a much more difficult fiscal environment,” Woodford added.
“What if growth fails to remain at these levels? What if inflation fails to return to the Bank of England’s 2 per cent target? In our view, these are both realistic concerns, so we have added what we believe are more realistic forecasts, using adjusted assumptions.”
The latest figures from the Office for National Statistics show UK GDP grew by 0.5 per cent in the fourth quarter of 2015, while the economy is thought to have expanded by 2.6 per cent over the whole year. Inflation, as measured by the consumer prices index, is down to 0.3 per cent.
Woodford Investment Management’s projections assume average real GDP growth of 1.8 per cent, which is the average between 2010 and 2014, and annual inflation of 1 per cent – which it adds could prove too optimistic an assumption in itself, given the weak inflation outlook.
The result of Woodford’s analysis is that the UK budget deficit does continue to reduce over the coming years, but not at the pace projected by the Government and not strongly enough to end in a surplus during 2018/19.
Indeed, the manager points out that his “more realistic” scenario leaves a cumulative hole of more than £120bn in the UK’s public finances when compared with the Government’s.
“We conclude that there is no room for complacency on the UK economy,” Woodford said.
“We believe it is appropriate to be cautious about the UK economic outlook, as indeed we are about the global outlook. There was nothing in the Budget to warrant a change to this cautious view in the near-to-medium term.”
Performance of indices over 3yrs
Source: FE Analytics
Neil Williams, group chief economist at Hermes, agrees that Osborne’s Budget was not as full of good news as the Chancellor made out.
“First, the deficit is still high. Even including special items like the transfer of the Royal Mail Pension Plan and QE profits, the likely 5 per cent of GDP deficit for 2014/15 will still be the G7’s widest after Japan. Second, while the headline deficit falls on better growth, the structural, less growth-sensitive part of the deficit will fall by less, begging further reform and consolidation,” Williams said.
“And, only this year is the net-debt-to-GDP ratio expected to have peaked, at 80 per cent. This is disappointing given real GDP is now 5 per cent up on its pre-crisis peak. This 80 per cent ratio is more than twice Japan’s was when Japan limped into a ‘lost decade’ in the mid 1990s.”
David Page, senior economist at AXA Investment Managers, also points that all the projections included in the Budget are subject to change in the coming months, should the general election result in a Government that chooses to embark on a different plan to the current coalition.
“As we argued before today’s Budget, the medium-term outlook of the current projections is less relevant than usual as it could change markedly after the upcoming election,” the economist said.
“Instead, this Budget is likely to have more relevance as to its impact on the election in nearly seven weeks’ time. The success or otherwise of today’s Budget will thus be judged by any reaction in the polls over the coming weeks.”