Government reveals economic projections
The government will need to borrow £55 billion less than it first thought over the next six years if economic growth forecasts are met – but independent commentators paint a less-than-rosy outlook.
Chancellor Alastair Darling forecast a rise in gross domestic product (GDP) - the measure of economic health - of between 1% and 1.5% next year, unchanged from previous forecasts. However, he revised down growth projections for 2011/12 by 0.25% to between 3% and 3.5%.
This is in line with Bank of England's projections.
Growth forecasts of 3.25% to 3.75% for 2012/13 remain unchanged, as they do for subsequent years. During the financial crisis the UK economy contracted by '‘around 6%", Darling says.
Healthy tax receipts in the past three months have contributed to a lower net public sector borrowing requirement (PSBR) than was forecast for the current year – down £11 billion to a forecast £167 billion. Darling reckons this will continue to fall in 2011/12 from a projected £131 billion to £74 billion by 2014/15.
The PSBR forecast breaks down as follows: next year the budget deficit will be £163 billion or 11.1% of GDP, down from a previous expectation of £176 billion. And in 2011/12, the chancellor forecasts the deficit to drop by £32 billion to 8.5% of GDP.
By the last year of the forecast period in 2014/15, the deficit will still be £74 billion or 4% of GDP, slightly lower than the £82 billion or 4.4% previously forecast.
Darling says overall debt as a percentage of GDP would rise from 54% this year to 75% in 2014/15 but would fall after that.
However, the £78 billion reduction in the budget deficit will be exceeded should the economy do better than Darling expects over the next four years.
While these changes may help to ease concerns over the immediate threat to the UK’s credit rating, fiscal worries are certainly not about to evaporate altogether, says Jonathan Loynes, chief European economist at consultancy Capital Economics.
Loynes reckons that while the cumulative borrowing forecast has fallen by £55 billion, this will only occur if the chancellor’s ‘over-optimistic’ economic growth predictions are met.
"At close to 12% of GDP, the UK’s budget deficit is still similar to that of Greece," says Loynes.
"And the forecast halving of the deficit over the next four years still relies both on spending cuts, which have not yet been properly detailed, and on almost certainly over-optimistic projections for the economy. In short, further decisive action to put the public finances back into a sustainable position will still be needed after the election."
His doubts are echoed by David Scammell, a fund manager in the fixed interest team at Schroder Asset Management. "There was no evidence of a credible plan to bring down the deficit," he says. "Also growth forecasts are far too optimistic – it’s difficult to forecast six months ahead let alone six years," he adds.
Nevertheless, government bond prices were only a little weaker after the chancellor sat down, and while the £184.4 billion of gilt issuance in the fiscal year is broadly in line with what markets were expecting, Scammell points out that this is a great deal higher than the £30-50 billion of issuance in more normal times.
Scammell believes it is inevitable that UK gilt yields are heading far higher, particularly in the 10-20 year range, where the Bank of England’s quantitative easing programme has been keeping yields artificially low. "My personal view is that the fair value yield on 10-year gilts is 5-6%, rather than the current sub-4% yield."
Expectations for inflation is one area where Scammell does agree with Darling’s forecasts - and is one of the few positives for gilt prices. Darling forecast that Consumer Prices Index inflation will fall to 2% next year. But the view at Schroders is that inflation has now peaked.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.