Is this really a ‘new age of optimism’?

1st November, 2021

Certainly, the Chancellor showed surprising largesse for a self-professed fiscal conservative. There was £150 billion extra cash for all government departments, notably education, equating to an annual rise of 3.8% in real terms. The cynical might argue that this only takes public spending back to pre-austerity levels, but either way, it shows a determined break from the recent past.

Sunak may have been encouraged to spend by revised forecasts from the Office for Budget Responsibility (OBR). It upgraded its forecast for the UK economy this year from 4% to 6.5%. However, this needs to be set in the context of some pretty savage falls in GDP in 2020 and the current growth forecasts of both the Bank of England and the IMF, which were considerably higher (7.25% and 6.8%). In retrospect the OBR forecast seems anomalous and its revision is therefore nothing to get excited about.

Amid the general optimism, however, there were some lurking horrors. The Chancellor admitted that inflation could hit 5%, echoing the warnings of the Bank of England’s chief economist a few days previously. The OBR has predicted that consumer price inflation will average 4.1% in 2022. This means the UK is far from through the worst of its inflationary problems and will offset some of the spending promises.

Another potential bogeyman is the growing sensitivity of the public finances to changes in interest rates. They are twice as sensitive to changes in interest rates as they were before the onset of the pandemic, and six times more sensitive than they were before the financial crisis. Just one percentage point increase in inflation would cost a heart-stopping £23 billion. To put that in context, that’s equivalent to all the public spending increases in this budget.

While the Bank of England acts independently, it will surely have public finances in mind before it raises rates. Even the 0.15% rise that is slated for the next monetary policy meeting could have an impact on the Chancellor’s fiscal wiggle room. That is likely to tie the hands of the central banks and makes a significant rise in rates less likely.

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This article was sourced from Adviser-Hub.co.uk.

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