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.