Chancellor addresses Covid threat, amidst broader Budget giveaway

• The Chancellor announces £12bn of spending to counter Covid-19 outbreak.
• The Chancellor announced £30bn of fiscal stimulus for this year (1.4% of GDP), in line with our expectation ahead of the event (1.5%).
• Budget otherwise conducted on premise of pre-virus projections.
• The Budget oversaw the largest increase in public spending since the early 2000s.
• This included a well-flagged increase in investment spending (of around £65bn), but a greater planned increase in day-to-day spending (£90bn).
• The Chancellor announced some measures to finance the increase in spending, but the bulk will be financed by net borrowing, rising to 2.8% of GDP next year and £97bn over the coming four years.
• UK public sector debt is now expected to start to rise again by 2023-24 and is currently expected at 75.6% of GDP, up from 73.0% envisioned a year ago.
• Planned gilt issuance has risen to £156.1bn – the largest planned issuance in nearly a decade. This borrowing requirement is likely to rise over the year.

Chancellor Sunak delivered his first UK Budget today. The Budget was a disjointed affair delivering a welcome second leg of stimulus to bolster the UK economy against the impending economic shock caused by the global outbreak of Covid-19. These measures were not included in the broader assessment of the public finances as the OBR closed its forecasts for this Budget before it anticipated the scale of the coronavirus. Hence the broader Budget was presented against a backdrop of a relatively benign economic projections. These allowed the Chancellor to announce the biggest increase in public spending, both investment, but also day-to-day spending since the early 2000s. The Chancellor delivered on manifesto commitments and added several populist measures – including fuel and alcohol duty freezes. And he managed to do so while maintaining a commitment to balance day-to-day spending by 2022-23, in part reflecting an OBR expected bounce to economic output next year. However, when these ‘projections’ are next updated in the Autumn Budget, there will be much more of a reckoning in terms of increased borrowing. By then, the Chancellor hinted that a review of the public finances might result in a change of the fiscal rule. We are highly supportive of the Chancellor’s short-term Covid-19 stimulus. We also recognise a growing role for government spending against a backdrop of low global interest rates. Yet we are wary of the scale of deterioration the UK public finances are likely to undergo over the coming year and await a clearer commitment to fiscal rules by this government.   

Covid-19 stimulus measures

UK Chancellor Sunak delivered the second leg of stimulus to the UK economy announcing a £30bn stimulus package (1.4% GDP), with £12bn (0.5%) in specific Covid-19 measures and an additional £18bn in other measures. These measures complement the package of measures introduced by the Bank of England earlier today in a well-coordinated response to the Covid-19 threat. A total stimulus package in the region of 2-2½% GDP provides material backing for the UK economy as it faces a shock of uncertain magnitude. The Chancellor added that the government’s stimulus could be further ramped up – particularly with regards to NHS funding – depending on the scale of the impact of Covid-19.

The Chancellor announced a series of measures specifically designed to protect the UK economy from the expected temporary shock of coronavirus, these measures included:

• Announcing extra resources for the NHS (£5bn has been ear-marked for now but this could vary over time).
• Protecting workers by easing access to Statutory Sick Pay and to benefits for self-employed and gig economy workers.
• Supporting businesses by refunding Statutory Sick Pay to small businesses (costing £2bn), scaling up “time to pay” measures to defer tax liabilities and providing government guarantees on bank loans to address Covid-19 disruption.
• Temporary reductions to business rates.
• £3k cash grants for SMEs.     
• The Chancellor stated that he had provided £12bn in spending measures directly aimed at limiting the damage of Covid-19 (£5bn so far for the NHS and £7bn for other measures).

Unsurprising given the swift evolution of the global outbreak of Covid-19, the Chancellor’s £12bn in coronavirus spending were a last minute adjustment to the broader Budget. The Office for Budget Responsibility’s assessment of the UK finances was carried out without allowing for this expenditure, and without taking account of it in its economic projections. This leaves these ‘projections’ in a strange limbo of describing the largest increase in public spending in nearly 20-years, but with economic and borrowing projections that will inevitably be heavily revised over the coming quarters.

Economic forecasts – the pre-virus outlook

In the pre-virus world, the OBR forecast UK economic growth slowing to 1.1% in 2020, from 1.4% - this was in line with our own forecast at the start of the year. It then expected to see a sharp rise in growth to 1.8% in 2021, before settling in around 1.4% (1.5%, 1.3%, 1.4%) in subsequent years. The OBR’s forecasts were underpinned by a healthy outlook for UK productivity growth, which it saw recovering from 0.8% this year to 1.3% in 2024, itself driving overall potential GDP growth rising from 1.2% this year to 1.6% in 2024. The OBR’s potential growth rate is more optimistic than recent (pre-virus) estimates from the BoE, which see potential growth remaining around 1.1% with productivity growth persisting at current subdued levels. The outlook is also more optimistic than our own outlook, which even pre-virus saw growth next year of just 1.0%. We fully expect a weaker growth outlook this year. Depending on the scale of shock this year, this could also see growth weaker next year. We also forecast growth to be slower than the OBR’s longer-term outlook, sharing the BoE’s more cautious outlook for productivity growth in the wake of several years of weak investment spending. A weaker growth outlook will likely weigh on the public finances relative to these forecasts. 

Measures – Chancellor undertakes significant increase in spending

Some of the OBR’s faster growth expectations were underpinned by a material easing in the fiscal stance of 0.7% GDP in both this financial year and next, envisaged in the pre-virus figures. The fiscal stance (cyclically-adjusted net borrowing) is now set to ease by 0.2% this year, compared with previous (Nov-19 updates) of a 0.5% GDP tightening, with 2021-22 seeing a similar easing of 0.6% compared with an expected tightening of 0.1%. The fiscal stance is then seen tightening by 0.2% of GDP more than previously envisaged (-0.3% per annum) for 2022-23 to 2024-25.

The fiscal easing is underpinned by a material increase in spending in this Budget. The Chancellor announced a £64bn increase in net investment spending over the four years 2020-21 to 2023-24. This saw investment spending rise towards the new limit of 3% of GDP announced under previous Chancellor Javid. The UK will see net investment at 2.6% this year, rising to 2.9% next year and reaching 3% thereafter. However, this Budget also saw an increase in spending of around £90bn over the same period. The bulk of this reflected an increase in the “envelope” for departmental spending, with details to be announced in the 2020 Spending Review in July. This envelope increase alone accounted for nearly £110bn of spending. However, spending was also lifted by an announced increased in the National Insurance threshold, a freeze on fuel and alcohol duties  and an increase in the Employment Allowance, amongst many other smaller measures.

The total increase in spending was somewhat offset by revenue raising measures. These included the pre-announced decision to leave the corporation tax unchanged at 19% (estimated to save nearly £25bn), a reduction in Entrepreneur’s Relief (£6bn), removal of the ‘red diesel’ relief for some sectors (£3bn) and an Immigration Health Surcharge, amongst other smaller measures. In total, tax receipts were forecast to rise by £56bn. There was also a £15bn saving from reduced debt interest spending. However, over the coming four years, the remainder was financed by borrowing, which is forecast to rise by £97bn over the period.

The public finances

The £97bn increase in net borrowing over the coming four years is set to see public sector borrowing rise as a % of GDP. This is forecast now to total 2.4% of GDP in 2020-21, up from 1.8% in 2018-19. This was forecast to be just 0.9% one year ago. The current projections see the deficit rising to 2.8% next year, before narrowing back to 2.5%, 2.3% and 2.2% in subsequent years. The Chancellor was able to announce that the current budget was still on track to be balanced by 2022-23, in fact projected at a surplus of nearly £12bn. Insofar as this commitment still constituted a fiscal rule for the government, we suggest a host of issues likely to prevent it being met going further forwards, including that the growth forecasts will likely be heavily revised and the spending commitments are larger than recorded here (by £12bn). However, Chancellor Sunak hinted at the likely demise of this commitment going forwards. He stated that the UK government needed to remain at the forefront of international fiscal best practice, that a broader debate was taking place about the appropriate mix of fiscal and monetary policy in the context of low interest rates and that he would review the appropriate role of fiscal policy over the coming months.

We concur that particularly in the current environment there is a more material role for government to play which is likely to temporarily lean in favour of greater government borrowing. That said, it remains to be seen whether this Chancellor is as committed to fiscal stability as some of his predecessors. The OBR’s forecasts now include an outlook  for public sector debt as a % of GDP to increase again, rising back to 75.6% by 2023-4 from 73.0% envisaged one year ago. The UK was forecast to return to a rising public debt burden just five years after it was thought to have passed its peak.

Gilt financing

The increase in borrowing has fed through to an immediate increase in planned gilt sales. These are now forecast at £156.1bn for 2020-21, the largest nominal sales target since 2012-13. The increase in gilt sales from £136.9bn in 2019-20 is driven by a rise in cash borrowing needs (CGNCR rising to £65.3bn from a revised £43.1bn), while an expected lower contribution from National Savings and no planned increase in T-bills also added to the gilt financing requirement. Nevertheless, the increase in planned gilt sales came in below the consensus expectation for gilt sales. However, we reiterate that these numbers are likely to be materially revised over the coming months as economic performance reflects the impact of the coronavirus. This is likely to lead to a larger borrowing requirement by year-end.

Amidst a significant day for UK announcements and financial markets in general, the 10-year gilt yield has held onto the modest 4bps rise recorded at the start of the day to 0.28% to close the day at 0.29%. Sterling has closed the day down 0.3% against the US dollar and flat to the euro despite the significant fiscal stimulus.