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- The OBR downgraded real growth across the forecast horizon but upgraded nominal growth forecasts on the back of higher inflation ahead.
- Ahead of what could well be an election year in 2024, the UK Chancellor’s Autumn Statement provided a 2ppt cut to national insurance contributions. We expect next March’s budget to provide further backing for a poorly polling Conservative Party.
- This was the main easing measure, which, along with higher assumed interest cost and higher welfare spend, the OBR sees as offsetting the higher nominal GDP benefit.
- Net borrowing requirement (% GDP) remains largely unchanged ahead versus in March. However, the higher nominal numbers are expected to mean higher DMO issuance.
- Despite modestly more expansive fiscal policy, we continue to see room for the BoE to cut as soon as May’s MPR. December’s labour market numbers will be key.
- Despite higher gilt issuance we continue to see room for UK bonds to outperform versus European government bonds.
Something for the Voters
UK government borrowing requirements through this fiscal year undershot March Office for Budget Responsibility (OBR) expectations, providing some headroom for fiscal easing (Chart 1). Such easing largely came in the form of reduced taxes, the majority of which was accounted for by a 2ppt cut to national insurance, expected to cost around £10bn pa (Chart 2).
For Conservative voters that will be a welcome change from the recent infighting. Polling in the high 20s, the Conservatives need some big wins before the next election (increasingly touted to be next year). Next March’s budget will probably provide more of this, but getting some early wins out was important.
Other adjustments included:
- Full expensing to be extended to permanency (100% deduction of investment spend from taxable revenues).
- Cutting departmental spending levels such that real spend will decrease over time due to the higher inflation forecast (note: the OBR assumes the reduction in under-spend will mean net-net this has little impact on public sector borrowing.
The measures, particularly the NIC cut, are estimated by the OBR to have around 0.3ppt pa positive real GDP impact. Despite this, and the fact that real GDP growth for 2023 was revised decently up to +0.6% from -0.2%, it was revised down across most of the rest of the horizon. However, the nominal GDP growth rate was higher over the horizon on the back of higher assumed inflation, and hence the GDP deflator (Chart 3).
UK government revenues, like most countries, should benefit from higher nominal growth given its impact on value-added, income and corporate taxes (Chart 2). However, the (higher than other countries’) inflation-linked composition of UK government expenditures will offset this: c.25% gilts linkers (along with higher yields and bank rates, this adds £23bn pa spend), and the triple-lock on pensions and inflation-linked welfare spend (adding £20bn pa by end of the horizon).
In sum, while the fiscal deficit as a percent of GDP was unchanged, the higher nominal GDP means greater assumed public sector net-borrowing (PSNB), and with it the central government net cash requirement (CGNCR), which the DMO uses to guide issuance.
The borrowing requirement for the current fiscal year was left broadly unchanged, with the DMO only really changing the distribution of issuance (Chart 5). Looking further out, the issuance is currently expected to be heavier in coming years (Chart 6).
A Modestly Expansionary Statement Unlikely to Move BoE
The BoE is unlikely to be too affected by the OBR’s increase in assumed inflation across the horizon, given it has its own inflation forecasts. However, the spending measures could have several impacts. For example, the NI cut (which is the bulk of the easing) will support aggregate demand, and all else equal be inflationary. There could be a modest offset if it encourages labour market participation (and hence loosens the labour market). The OBR predicts it could drive a rise of 94k FTE although this mostly comes from greater hours worked, not higher employment.
Measures such as the extension of full expensing could have a positive impact on the supply-side. Supporting corporate profitability could mean less cost pass-through to customers, and yield supply-side benefits into the medium-term. But these are mostly marginal changes.
The BoE’s main priority should remain the labour market’s near-term weakening (which we have an update on 12 December) and whether their expectations for slower loosening is realistic. Until then, we continue to think the BoE will pause, with the corrected labour market ultimately showing faster labour-market loosening than they had forecast.
We think the BoE could cut as soon as the May MPR.
How Does the UK Autumn Statement Compare to Europe’s Budgets
We have previously covered the European budgets in detail. We continue to see three main reasons why UK gilts should perform better than European bonds ahead:
- The UK economy is weaker; closer to recession than in other countries (risk-off should support gilts).
- European countries are far more bullish on their growth prospects than the UK. This means more risk of upside surprises in European issuance than UK relative to what the market is pricing (as was the case in 2023, Chart 7).
- BoE QT is heavy and well priced in. It is unlikely to accelerate, but could (potentially) slow if needed. There is by contrast little priced in expectation for ECB QT acceleration (coming via an earlier end to PEPP reinvestments).
Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.