Hammond dealt tricky hand from £20bn Budget black hole - IFS

A ballooning public deficit could create a near-£20bn hole in the budget and make it hard for Chancellor Philip Hammond to concede to the growing demands for more public spending, new research from the Institute for Fiscal Studies suggested on Monday.

Ahead of the Budget reading on 22 November, the influential thinktank has calculated that by 2021/22 Britain’s deficit will remain at £36bn, almost double the £17bn previously forecast by the Office for Budget Responsibility.

Economists, including the Bank of England, have downgraded their medium-term gross domestic product forecasts since the beginning of the year, indicating the economy will be 0.4% smaller in 2021–22 than forecast by the OBR in March.

But the IFS is not alone in expecting the OBR to downgrade even more than this, given the terrible productivity growth that the UK has experienced since 2010.

"Any substantial downgrade to productivity forecasts would easily dwarf the other factors affecting borrowing and lead to the medium-term outlook being worse than in March," the IFS said, with the borrowing forecast changes dependent on the extent of the productivity downgrade.

But even if the OBR downgrades its growth forecasts in line with the consensus, other factors could mean borrowing forecasts being revised down overall.

But in what the thinktank felt is a more likely scenario that OBR decides the limp productivity of the last seven years is the new normal, then structural borrowing would rise above 3% of national income, close to £70bn in 2021–22 and rise further thereafter, unless further policy action is taken.

Even in a lukewarm scenario where future productivity growth is downgraded halfway towards that seen over the last seven years, the deficit in 2021–22 could be around 1.6% of national income.

At around £36bn, this would be almost £20bn higher than the £17bn forecast by the OBR in March.

"This could be even higher if the underlying improvement in the public finances this year were judged to be a temporary phenomenon," the IFS report said, rather than acting to reduce 2021–22 borrowing by £12bn.

Under the lukewarm scenario, the Chancellor would still be on course to meet his fiscal mandate of keeping structural borrowing below 2% of national income in 2020–21, albeit having lost around 50% of the headroom he had just eight months ago, which would raise the likelihood that the target would be missed unless further policy action were taken.

"Achieving the Chancellor’s overarching fiscal objective of eliminating the deficit by the mid 2020s – a challenge even on the March forecasts – would be considerably more difficult if this weak productivity growth were to materialise."

Meanwhile, pressures on public service spending are making painful headlines for the government, most notably public sector pay, the NHS and prisons.

The IFS acknowledges that Hammond "has been dealt a very tricky hand indeed".

"The political arithmetic makes any significant tax increase look very hard to deliver. It looks like he will face a substantial deterioration in the projected state of the public finances. He will know that seven years of 'austerity' have left many public services in a fragile state.

"And, in the known unknowns surrounding both the shape and impact of Brexit, he faces even greater than usual levels of economic uncertainty."

It is unlikely he will be able to signal ‘the end of austerity’, he is likely to remain on course to meet his target of a structural deficit of no more than 2% of national income by 2020–21, if by a much reduced margin.

"It looks increasingly unlikely that the ever-receding target to get rid of the deficit altogether will be achieved by the mid 2020s, which is when that is currently supposed to happen.

"Of course, it is possible that the economy, or the public finances, will perform much better than expected. But given all the current pressures and uncertainties – and the policy action that these might require – it is perhaps time to admit that a firm commitment to running a budget surplus from the mid 2020s onwards is no longer sensible," the report concluded.