• The Chancellor can expect a budgetary windfall from improved economic performance
• Ongoing COVID costs, inflation and higher gilt yields will be pulling in the other direction
• The Chancellor will probably catch a lucky break on interest rates
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Next week the OBR will deliver a mixture of windfalls and millstones for the Chancellor to manage. While nobody expects them to be correct, the OBR forecasts are important because they provide the financial framework within which Budget decisions are made. Economically, things have generally turned out a lot better than the last fiscal forecast, delivered in March. Public finance figures for August show that year-to-date borrowing is now some £31.9 billion below where the OBR expected it to be at the last Budget. That gives the Exchequer some much needed wriggle room, but there are also big budgetary headwinds the Chancellor will have to confront too.
“As the OBR pointed out in March, the spring Budget made no provision for virus-related spending costs beyond the end of this fiscal year. The Treasury will be announcing a three year Spending Review for government departments alongside the forthcoming Budget. That means the Chancellor will surely have to address the longer term legacy the pandemic will leave behind, such as the ongoing costs of test and trace and booster programmes, dealing with the NHS treatment backlog, repairing the black hole in rail fare revenues, and making up for lost teaching hours. Against a backdrop of record levels of debt, these additional cost pressures look like they will weigh heavily on the purse strings of the Exchequer.
“The OBR’s inflation expectations will also be a key factor in the health of the public finances, and of course of wider interest to consumers and businesses, who are already experiencing price rises. When the OBR last issued their economic forecasts in March, the UK was in lockdown, the furlough scheme was in full flow, and the success and efficacy of the vaccine programme was still in the balance. Consequently, the OBR expected oil prices to rise, but only to an average price of $54 a barrel for this fiscal year; the price currently stands at over $80 a barrel. The budget watchdog thought CPI inflation would undershoot the Bank of England’s target at 1.5% for 2021 and 1.8% for 2022. The latest reading of CPI inflation was in fact 3.1%, and the Bank of England has forecast inflation of 4% this winter, and that was before the recent surge in energy prices.
“We can therefore expect a big jump in the OBR inflation forecast at the forthcoming Budget, which will mean the government paying more interest on the £490 billion of outstanding inflation-linked gilts in the market. It will also increase the forecast for government borrowing costs through new gilt issuance and the QE programme, because yields and rates have increased significantly since March, when negative base rate was firmly on the agenda. The OBR forecasts were probably signed, sealed, and delivered before the latest spike in gilt yields, and before Andrew Bailey’s comments raised expectations of a November rate hike. That timing could prove to be a lucky break for the Chancellor. A more up to date market measurement would cost him significant sums over the forecast period at this Budget. What he dodges this time will come around to bite him in March, but a lot can happen between now and then, so he won’t be worrying about that just yet.”
