This Budget will be a walk in the park for the Chancellor, but there are still mountains to climb

Published on Public Finances and the Economy

Budgets are generally a stressful time for Chancellors. Explaining whatever news the economic forecasts throw up, selling your big policy shifts and avoiding the opposition unravelling the Budget small print is normally enough to raise the blood pressure of those in Number 11.

But this week is likely to feel like a walk in the park for Philip Hammond. The forecasts will be less grim than the truly awful ones set out a little over three months ago at the Autumn Statement. Growth up and borrowing down as post-referendum Britain exceeds expectations will be the headlines. An expected £12 billion reduction in borrowing this year means the UK having a deficit of around £55 billion, the same level the Office for Budget Responsibility (OBR) forecast before the EU referendum.

On the politics, the opposition has been too busy explaining a Cumbrian by-election loss to land any blows in recent weeks.

Policy wise the Chancellor needs to find money to ease social care pressures and soften the blow of higher business rates for some firms, but the sums involved are unlikely to trouble the overall Budget arithmetic and everyone supports the measures anyway. The Chancellor is likely to return to the public finance risks from growing self-employment, but the challenge of explaining more difficult tax reforms, and the losers that come with them, looks set to be delayed until the Autumn.

So on the forecasts, politics and policy it doesn’t look like a difficult first (and last) Spring Budget outing for the Chancellor. But if we leave aside the theatre of the Budget and focus on its substance the challenges facing Philip Hammond remain significant.

On borrowing Brexiteers will, with some justification, herald improvements as a sign that the gloom of the Autumn was overdone. But they should be cautious. The OBR is also likely to be forecasting that, by 2020, borrowing will remain in the region of £20 billion higher than they thought pre-referendum. The jury, far from being in, hasn’t even been selected on the long term effect of Brexit on the public finances.

Crucially, given the Prime Minister’s focus on the living standards of ordinary working people, those challenges extend from the public to family finances. At every Budget people pay close attention to the borrowing and growth numbers, but those seeking an insight into the economics and politics of the coming years would do well to look elsewhere this time – to the OBR’s inflation forecast. Living standards are after all a primary concern for the electorate – and prices are the half of the living standards story we often forget.

We already know from the Autumn that the OBR expects faster price rises as the post-referendum fall in the value of the pound pushes up the prices of imports, building on pre-existing pressure from rising oil prices, and meaning that both the OBR and the Bank of England expect the Bank’s 2 per cent inflation target to be exceeded for most of 2017 and 2018. Neither the OBR or the Bank expect wage rises to increase much to keep pace with inflation being higher than previously expected – economist speak for saying we’re all going to be poorer than hoped.

Far from improving with the other forecasts, if anything the news since the Autumn Statement leads us to expect a slightly higher inflation forecast from the OBR on Wednesday. Firstly, we’ve seen rising imports costs feed through into prices in the shops with inflation reaching 1.8 per cent in January (the highest since mid-2014). Secondly, sterling has marginally weakened against both the dollar and euro since the Autumn Statement on 23 November. Lastly, the oil price has continued to rise, up by around 10 per cent since that date.

If the OBR follows the pattern of external forecasters since November it will revise up its inflation forecast to 2.6 per cent this year and next. That would increase the chances of real pay actually falling towards the end of this year as price increases outstrip pay rises.

Across the rest of this Parliament it would mean even slower pay growth leaving average earnings in 2020 only just higher than those seen in 2005-6, a full fifteen years before. It’s hard to understate how catastrophic an outcome that would be if it came to pass.

The effect of a renewed pay squeeze would be broadly felt across the population, but in many ways the worst affected group might be those ‘ordinary working families’ on lower incomes who will face a double whammy of lower pay growth and benefit cuts. That’s because the tax credits and other benefits they rely on are frozen for the next three years as part of the government’s attempt to cut the social security bill. Every time inflation rises it increases the size of this cut. If the OBR’s forecast matched that above it would mean that this benefit freeze would amount to a 6.5 per cent real-terms cut over the parliament. That’s an extra £1.3bn a year by 2020, or £3.6bn over the parliament, compared to what was expected at Budget 2016.

Today these benefit cuts – along with further cuts to Universal Credit – that Philip Hammond has inherited from his predecessor look dangerously out of place. The good news is they can be reduced without undermining the still challenging public finances by scrapping planned inheritance, corporation and income tax cuts worth billions of pounds – and which overwhelmingly benefit better-off households.

The Chancellor will have an easy ride this week, but it’s the challenges of the years ahead that really matter. He cannot simply wish a stronger pound, lower inflation or bumper pay rises into being. But by reprioritising tax and benefit support he could give Theresa May’s admirable political focus on the living standards of working people a fighting chance of being delivered upon.