More aggressive, still ambitious
The Chancellor made his intentions very clear early into his speech by declaring the fiscal mandate to be the removal of the cyclically-adjusted current budget deficit by the end of the Parliament (2014/15).
Relative to the figures contained in the forecasts released by the Office for Budget Responsibility (OBR) on June 14, this implied an additional tightening of around GBP29bn by 2014/15. In the event, the Chancellor is in fact setting the bar a little higher by forecasting a surplus of 0.3% on this measure by 2014/15, implying an overall additional tightening of closer to the GBP37bn mark.
Most of the tax measures were in line with earlier estimates and the spilt between the fiscal tightening produced by the expenditure cuts and tax increases announced today will, by 2014/15, move towards a 77:23 ratio, but in the short-term the burden of consolidation will fall more evenly between the two areas and tax increase. The increase in the rate of VAT from 17.5% to 20% effective Jan 4th is seen as particularly important and will play a key role in the early improvement within the public finances. The decision not to increase the income tax threshold beyond the move to GBP7,745 in 2011/12 may be seen as a disappointment by some, but this was always likely to prove a very expensive policy to implement and the gradual decline in the rate of corporation tax from 2011 onwards is a noteworthy and offsetting factor.
The bigger 'news' contained within the Budget undoubtedly related to cuts in government expenditure, whether relating to departmental spending limits, public sector pay or welfare payments. These were a little more aggressive than anticipated and explain the difference between our own forecasts for borrowing beyond 2012/13 and the Treasury's (reduced) projections.
The earlier plans for net capital expenditure to fall from around 3.6% of GDP currently to less than 1.5% by 2014/15 were maintained and the reduced borrowing forecasts relate to a sharper profile of cuts being pencilled in for current expenditure. The share of total managed expenditure in GDP is planned to fall from around 47% currently to less than 41% by 2014/15, assuming some very large real-terms cuts in departmental expenditure limits along the way. The exact focus of these will remain unclear until the publication of the Comprehensive Spending Review (CSR) in October, but areas outside of healthcare may expect to see real term declines approaching 25% over four years.
Given the severity of these cuts, the relatively small cuts to the OBR's earlier growth forecasts was perhaps a further surprise, and a closer look at the forecast for 2.3% growth in 2011 (from 2.6% previously) points to the potential for disappointment ahead. A positive contribution from net trade of 0.9ppt is now assumed in 2011, something which we view as optimistic given the poor performance of UK exports to date.
Overall, therefore, today's Budget should be seen as an ambitious attempt to address the structural frailties of the UK's budget position. Gilt markets have certainly reacted positively, and given that these plans compare favourably with most efforts seen across the US and Euro-zone, we would also view the contents of the Budget as positive for sterling. But until the cuts in current expenditure are appropriated in the October CSR, some questions will remain and the revised OBR growth forecast, although reduced, still appear somewhat optimistic.