This Pre-Budget Report, Gordon Brown's tenth and probably last before, he hopes, moving next door to No 10 had considerably more room for latitude than the previous offering benefiting as it had from £2bn extra from North Sea taxes and a lengthening of the economic cycle, both forward and back, to ensure that precious fiscal rules remained intact. By so doing the Chancellor could use this set piece, not just to help prepare for his own elevation but also to pave the way towards next summer's Comprehensive Spending Review (CSR).
That said, the public finances are not so robust as to provide Mr Brown with a huge amount of wiggle room and what we got, in the end, was an estimated net £2bn tightening in fiscal policy each year from 2007-08. This should be sufficient to ensure that the public finances continue their very gradual improvement in the near-term, but the period following 2007/08 will be dominated by the conclusions of the CSR. Given the aggressive nature of current assumptions for that period (a 5% drop in spending growth! Can you see it happening?) Mr Brown's successor is going to have to be forged from something stronger than iron.
Revisions to UK GDP
Revisions to overall UK Gross Domestic Product (GDP) were as expected. The Chancellor is now forecasting growth of 3.00% over 2006/07, close to 3.0% in 2007/08 and a 0.25% lower forecast, at 2.5%, for 2008/09. Despite the economy's strength the public finances are, this year, expected to emerge about £1bn below forecast. Even after the measures aired in this PBR, which are thought to raise taxes by c£2.2bn over 2007/08 (around half of which is derived from the doubling of air passenger duty) the Chancellor has still increased his medium term borrowing projections.
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The surplus on the current budget is reduced by £11.4bn in the five years from 2006/07 while Public Sector Net Borrowing (PSNB) is increased by a cumulative £7.3bn. On balance we got more of what we're used to from a macro economic perspective i.e. the Chancellor recognises a steady downward slide in the surplus on current budget and an equivalent upward move in PSNB. Hugely significantly though, in order that the downward trend in borrowing be maintained without an increase in taxes as a share of GDP, spending must grow by less than 5% each year from 2008/09! Who would take the job Mr Brown seems shortly to vacate and prescribe that medicine ahead of a general election?
Closing the output gap
One of the major historical differences between the Treasury and the Bank of England has been the assessment of the output gap. Back in March the Budget envisaged an output gap equivalent to c1% of GDP, widening on the numbers then supplied, to 1.5% over 2007. However, statisticians have come to the Chancellor's aid again. 2003, 2004, 2005 and 2006 GDP have all been upwardly revised by 0.25% points resulting in what now looks like a closer correlation between the Treasury and the MPC. Given that the estimate for trend GDP growth has been increased from 2.5% to 2.75% (largely a function of increased immigration, not an improvement in productivity), the current assessment is for an output gap of c0.25% of GDP, a sharp decline from the position held at the Budget last March. This point, coupled with the remarkable proximity between both the Treasury and Bank's GDP and CPI projections, indicates that it is not just the output gap that has been closed over the past eight months!
By Jeremy Batstone, Director of Private Client Research at Charles Stanley
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