Budget cuts could hold back UK's growth

Budget cuts could hold back UK's growth

Spending cuts and tax hikes outlined in the emergency Budget will weaken economic growth by more than previously forecast over the coming years, warn City economists.

Chancellor George Osborne predicted growth of 1.2% this year – down slightly on the 1.3% forecast from the newly-formed Office for Budget Responsibility (OBR) before rising to 2.3% the following year. This is further below the OBR’s forecast of 2.6%.

However, from that base the UK economy is set to steadily grow to 2.9% in 2013 – above the OBR’s own forecasts as the private sector gathers pace and interest rates remain low.  

Osborne’s five-year pledges were more aggressive than many economists had been anticipating with an extra tightening worth  £40 billion a year by the end of the Parliament on top of the £44 billion which was built into the previous governments fiscal plan.

Hetal Mehta, senior economic adviser to the the economic forecasting group Ernst & Young ITEM Club, says: “We feel that the objective to eliminate the cyclically-adjusted current deficit by 2014-15 is quite ambitious, but commendable.

 "With fiscal policy much tighter, one would expect a slower economic expansion, which is what the revised OBR projections show. This consistency is heartening and safeguards the credibility of the new framework. The pace of tightening announced should placate the markets.”

Osborne said 77% of the fiscal tightening will come from spending cuts – to be outlined in the Spending Review in the Autumn - with the remainder from tax hikes.

Although many of these will not come into play until 2011, many economists were applauding the decisive action. 

Royal London Asset Management's economist, Ian Kernohan says: “The government is gambling that a classic Rubinomics approach of taking the fiscal pain upfront will avoid a double dip recession and ensure economic recovery and eventual re-election, by keeping markets on side and interest rates and gilt yields low. 

Credit rating agencies may also take heart from the government’s predictions that the deficit, measured as a percentage of GDP is forecast to tumble from 10.1% this year to 1.1% at the end of the Parliamentary term. The likes of Fitch has been hinting that it could slash the UK’s prized AAA rating unless decisive action is taken and warned that the UK’s deficit must stand below 3% in the next five years. 

Analysts at Whitechurch Securities say: “We believe that the projected savings and the revised growth numbers should keep the ratings agencies happy and bond and equity markets relatively stable.”  

However, some economists warned that the Chancellor risks derailing the recovery. 

KPMG chief economist Andrew Smith says: “This is a kill or cure budget. The aim is to eliminate the structural deficit over this parliament, but it risks choking off the recovery. 

“There is no guarantee that private demand will rebound just because the government retrenches. The deficit is large because private demand is weak, not the other way round. So consumers and businesses may opt to continue to save and rebuild their balance sheets, rather than spend and invest.”