The Office for Budget Responsibility’s (OBR) public finance forecasts in a no deal scenario published in its Fiscal Risks Report this week really do look pretty dreadful. We suspect they overdo the gloom a bit. But either way, whether it is Boris Johnson or Jeremy Hunt that wins the keys to No. 10 next Tuesday, they may well ignore it.
The Office for Budget Responsibility’s (OBR) public finance forecasts in a no deal scenario published in its Fiscal Risks Report this week really do look pretty dreadful. We suspect they overdo the gloom a bit. But either way, whether it is Boris Johnson or Jeremy Hunt that wins the keys to No. 10 next Tuesday, they may well ignore it.
Contrary to some of the press headlines this week, the no deal forecasts published by the OBR were not what the fiscal watchdog thinks would happen to the economy after a no deal. Instead, the OBR took the IMF’s no deal forecasts and used those to illustrate what they may mean for the public finances.
However, this is just one no deal scenario. The economic consequences of a no deal will crucially depend on the extent of the preparations, the tariffs, how policymakers respond and the state of the relationship between the UK and the EU. For what it’s worth, our own no deal assumption is not as bad, primarily due to a decisive fiscal response. (See here.) We assume a 1.5% hit to GDP by the end of 2021, compared with the IMF/OBR’s 3.9%.
In any case, we doubt the OBR’s dire warnings – that a no deal would push up borrowing by £30bn a year from 2020/21 onwards relative to its deal forecast and leave public sector net debt 12% of GDP higher by 2023/24, at 85.1% – will prevent the new PM from pursuing a no deal on 31st October.
Nor will it keep either Boris Johnson or Jeremy Hunt from loosening the purse strings in that scenario – although there is clearly a big question mark over whether the candidates really intend to introduce all the pledges announced over the past few months, which would come with a hefty price tag (ranging from £20bn to £40bn a year)!
Indeed, if push came to shove, we think that the new PM would decide that loosening policy to give the economy a boost is more important than keeping the current fiscal rules intact, perhaps arguing that exceptional circumstances allowed the rules to be suspended. After all, the political damage from letting borrowing rise and breaking the fiscal rules would surely be less than failing to support consumers and firms after a no deal.
Ultimately, a big discretionary loosening in fiscal policy is probably on the way regardless of the politics. What is unclear is whether this comes alongside lower borrowing (if there’s a deal) or much higher borrowing (if there’s a no deal).
Signs of life after recent soft patch
As far as the current health of the economy goes, the economic news this week has been fairly encouraging. Admittedly, employment rose by just 28,000 in the three months to May – continuing the deceleration in employment growth which has been evident since January. (See here.) And unemployment only managed to fall by a larger 51,000 because people gave up looking for work to join the ranks of the inactive. But some slowdown in employment growth was always likely as firms increasingly struggle to find suitable staff.
What’s more, after the declines in April and May, the retail sector has flickered back to life, with retail sales rebounding by 1.0% m/m in June. (See here.) This has prompted us to push up our estimate of Q2 GDP growth from -0.1% q/q to 0.0% q/q. Clearly no change in GDP is still a worry in itself, even after the solid 0.5% q/q rise in Q1. But that would at least be a bit easier to stomach than a contraction.
Meanwhile, at 2.0% in June, inflation remained just where the Bank of England wants it to be. And so far, there have been few signs of rising underlying price pressures. (See here.) This supports our view that even in a deal scenario, interest rates will remain on hold for at least another year – although when the MPC does move, we think that a rate hike is more likely than a rate cut. (See here.) And in a no deal, inflation won’t prevent rate cuts.
Week Ahead
The results of the Tory leadership contest will announced on Tuesday. Boris Johnson still looks a shoo-in for PM.
Economic Diary & Forecasts
Upcoming Events & Data Releases | ||||||||
Date | Country | Release/Indicator/Event | Time (BST) | Previous* | Consensus* | CE Forecasts* | UK Data Response | |
Mon 22nd |  | UK | No Significant Data Released | – | – | – | – | – |
Tue 23rd | | UK | Winner of Tory Leadership Race Announced | – | – | – | – | – |
| UK | CBI Industrial Trends Survey (Jul) | 11.00 | -15 | -15 | -15 | – | |
| UK | BoE’s Andy Haldane Speaks | 13.15 | – | – | – | – | |
Wed 24th | | UK | Theresa May to Resign as PM | – | – | – | – | – |
Thu 25th | | UK | Parliament Breaks for Summer Recess | – | – | – | – | – |
| UK | CBI Distributive Trades Survey (Jul) | 11.00 | -42 | 0 | +5 | – | |
Fri 26th | | UK | No Significant Data Released | – | – | – | – | – |
Also expected during this period: | ||||||||
29th – 1st | | UK | Nationwide House Prices (Jul) | – | +0.1%(+0.5%) | – | – | – |
Selected future data releases and events | ||||||||
Mon 29th | | UK | Net Consumer Credit (Jun) | 09.30 | – | – | – | – |
| UK | M4 Money Supply (Jun) | 09.30 | – | – | – | – | |
Wed 31st | | UK | GfK Consumer Confidence | 01.00 | – | – | – | DR |
Thu 1st | | UK | Brecon and Radnorshire By-election | – | – | – | – | – |
| UK | IHS Markit/CIPS Manufacturing PMI (Jul) | 09.30 | – | – | – | DR | |
| UK | BoE Monetary Policy Decision | 12.00 | – | – | – | DR | |
| UK | BoE Inflation Report | 12.00 | – | – | – | DR | |
*m/m(y/y) unless otherwise stated Sources: Bloomberg, Capital Economics | ||||||||
Main Economic & Market Forecasts** | ||||||||
%q/q(%y/y) unless stated | Latest | Q1 2019 | Q2 2019 | Q3 2019 | Q4 2019 | 2019 | 2020 | 2021 |
GDP | +0.5(+1.8) | +0.5(+1.8) | 0.0(+1.4) | +0.5(+1.2) | +0.3(+1.3) | (+1.4) | (+1.5) | (+2.0) |
Household spending | +0.6(+1.9) | +0.6(+1.9) | +0.4(+1.7) | +0.4(+1.7) | +0.5(+2.0) | (+1.8) | (+1.9) | (+1.7) |
CPI inflation (%) | (+2.0) (Jun) | (+1.9) | (+2.0) | (+2.0) | (+2.0) | (+2.0) | (+2.4) | (+2.2) |
ILO unemployment rate (%) | 3.8 (May) | 3.8 | 3.9 | 3.9 | 4.0 | 3.9 | 4.0 | 4.0 |
Bank rate, end period (%) | 0.75 | 0.75 | 0.75 | 0.75 | 0.75 | 0.75 | 1.00 | 1.25 |
10 yr gilt, end period (%) | 0.76 | 1.00 | 0.83 | 0.92 | 1.00 | 1.00 | 1.25 | 1.75 |
$/£, end period | 1.25 | 1.32 | 1.26 | 1.25 | 1.25 | 1.25 | 1.30 | 1.35 |
Euro/£, end period | 1.11 | 1.17 | 1.12 | 1.15 | 1.19 | 1.19 | 1.13 | 1.17 |
Sources: Capital Economics, Refinitiv | ||||||||
** Based on a scenario in which Brexit is repeatedly delayed. For forecasts based on a deal or a no deal, please see our UK Economics Update “Pick your own Brexit forecast”, 1st July 2019.
Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com