Britain's Chancellor of the Exchequer Jeremy Hunt - STEFAN ROUSSEAU/POOL/AFP via Getty Images
Britain will avoid falling into recession this year as tumbling energy prices and higher immigration help the economy to avoid a prolonged downturn.
The Office for Budget Responsibility (OBR) said the economic outlook had "brightened" since its last official forecast in November, predicting a "shorter and shallower" downturn, and a faster fall in borrowing and debt.
However, the Government's tax and spending watchdog also warned that households still faced the biggest two-year squeeze in living standards on record. The tax burden remains at a post-war high and overall business investment is set to remain anaemic.
It added that the fallout from Russia's war in Ukraine and lockdown measures during the pandemic will continue to weigh on the economy for years to come.
Growth
Britain is supposed to be in the middle of a year-long recession. Back in November, the OBR said the UK economy had started shrinking in the second half of 2022, and would not emerge from the downturn until the end of this year.
The independent body no longer believes this is the case.
While officials still expect the economy to shrink by 0.2pc this year, it thinks a technical recession – defined as two straight quarters of economic decline – is no longer on the cards.
The projected decline is also much shallower than its previous forecast for a 1.4pc drop. Instead, the economy is expected to shrink by 0.4pc in the first three months of 2023, before flatlining in the second quarter.
The economy is then expected to grow 1.8pc in 2024 and 2.5pc in 2025 as the recovery gains traction, before slowing to 1.9pc in 2027 when the economy hits its maximum speed limit.
"We now expect a shorter and shallower downturn in the first half of this year," said Richard Hughes, the OBR's chairman.
"This is a consequence of lower energy prices and interest rates reducing some of the near-term pressures on spending by households and businesses. The good news is that the economy is expected to shrink by just 0.5pc from peak to trough, much less than the 2pc fall forecast in November."
The bad? The economy will remain smaller than its pre-lockdown size until the middle of next year. Every other G7 economy is already larger.
The OBR's latest forecasts remain significantly more optimistic than the Bank of England, which currently predicts the economy will shrink this year and next.
David Miles, an OBR official who used to set interest rates at the Bank, said the differences were explained partly by an assumption that UK households will start raiding their savings as the squeeze on living standards continues.
Recent data suggest people are holding on to the extra money they saved on travel, lunches and going out during lockdown.
Even Jeremy Hunt is privately sceptical about this assumption. Mr Miles said that while it "sounds extraordinary, actually, it's not extraordinary.
"Historically, it's been quite common for the household savings rate to be that low."
Mr Miles also expects the Bank to upgrade its forecasts to take into account the boost from a bigger workforce and stronger economy.
The UK's post Brexit immigration policies will also lift growth, while lower gas prices will help the UK's long-term prospects.
Inflation
Rishi Sunak has pledged to halve inflation by the end of 2023.
By this measure, the Prime Minister is more than on track. Inflation is now due to fall more sharply than the OBR forecast back in November. It expects that the rate will drop from its peak of 11.1pc in October to 2.9pc by the end of 2023. This is close to the Bank of England's 2pc target.
"The end result of lower inflation is less economic damage," says Barret Kupelian, senior economist at accounting firm PwC.
But better headline figures will not bring much immediate relief for households.
The lower inflation forecast is due to falling gas and electricity prices and the easing of supply bottlenecks, which will flow through to the price of goods. Here, the energy price guarantee becomes a double edged sword.
The OBR says it will knock 0.7 percentage points off the headline rate in 2023-24 when taken together with the fuel duty freeze and changes to alcohol duty. However, a fall today just means more stubborn inflation later, with the impact of subsequent increases to fuel and alcohol duties and the EPG measure then adding 0.4 percentage points to the CPI rate in 2024-25.
Also, while energy prices are expected to cool, food price inflation will remain high.
And the strain will be worse in the less well-off parts of the UK.
"The rising cost of living is likely to exacerbate the differences in economic performance across the country this year, widening regional inequalities," says Rohan Malik, Government and Infrastructure Leader at EY.
In 2024, the OBR expects inflation will fall sharply to 0.9pc before hovering around zero until the middle of 2026. It will not return to the Bank of England’s target rate of 2pc until 2028.
Living Standards
While falling inflation offers some respite for households, it will not be enough to save families from the worst drop in living standards on record.
A toxic cocktail of inflation and high taxes mean that real household disposable income – the amount of money a person takes home after taxes and inflation are accounted for – will plunge by 5.7pc in the two years to April 2024.
While this is not as bleak as the cumulative 7.1pc drop the OBR expected back in November, it represents the steepest drop over any two year period since at least 1956.
As inflation eases, real incomes will start to rise again in 2024, but there will be no big bounce back. Next, households will have to grapple with the insidious effects of Mr Hunt’s frozen income tax and national insurance thresholds.
The fiscal drag from these freezes will quietly push millions of taxpayers into higher tax bands – and mean millions more will start paying tax for the first time. This will take a major chunk out of people’s paychecks.
By 2028, real living standards will still be down 0.4pc compared to pre-pandemic levels. That means the average person will still have less money to spend than they did eight years earlier.
Paul Johnson, director of the Institute for Fiscal Studies, a think tank, said: "We are still in the midst of an enormously difficult period for households. We’re by no means out of the woods yet."
Migration
Net migration into Britain by foreign workers, students and families is set to average 245,000 a year and total 1.6 million under post-Brexit reforms, according to official estimates.
The Office for Budget Responsibility (OBR) has been forced to upgrade the figure from the 205,000 it estimated just five months ago. It represents a marked contrast to pledges by previous Tory leaders to bring net migration below 100,000 a year
It has been fuelled by a more liberal approach to post-Brexit immigration by Boris Johnson which saw his points system open up half of all jobs in the UK to foreign workers, by lowering salary and skilled thresholds for migrants and lifting the cap.
The numbers of foreign workers granted visas have nearly doubled from 170,500 to 331,000 in the past year, predominantly coming from non-EU countries since the end of freedom of movement required EU workers to get visas. They have been led by workers from India (110,000), Philippines (21,900) and Nigeria (17,500).
The new foreign graduate visa allowing students to stay in the UK for two years after completing their degree has seen overseas students' numbers jump by more than two-thirds from 286,000 to a record 492,000 last year.
With humanitarian visas to Ukrainians topping 210,000 and 129,000 Hong Kongers taking up British National Overseas (BNO) visas, last year saw net migration hit a record high of 504,000, before the projected fall to 245,000 a year as students, workers and potentially Ukrainians leave the UK.
The OBR estimated that migration would account for an increase in employment growth of 160,000, bigger even than the 110,000 job growth projected from all the childcare and other employment measures laid out in Jeremy Hunt’s budget.
Madeleine Sumption, director of Oxford University’s Migration Observatory, said the post-Brexit immigration system was largely admitting foreign high-skilled workers with one exception: care workers, of which about 50,000 entered the UK last year.
"It's the kind of work being admitted not because the job requires a lot of formal training like most of the other jobs in the immigration system but because there's a significant shortage," she said.
With the construction industry also facing chronic shortages, the Government yesterday placed bricklayers, roofers, tilers, slaters, carpenters, joiners and plasterers on the shortage occupation list allowing migrants from overseas to come to the UK to do those jobs.
Government migration advisers justified the relaxation rules because of the "strategic importance" of the construction industry for the British economy. It rejected a similar move for hospitality in its interim report, published with the Budget.
Borrowing and Debt
The OBR said the improvement in the UK's economic prospects had "flowed through to a somewhat brighter outlook for the public finances''.
Borrowing this year alone is expected to be £24.7bn lower relative to its November forecast thanks primarily to higher tax receipts and lower spending on energy bills support, despite the extension of the EPG.
The OBR said the outlook for borrowing had "improved materially since November", with this year's improvement expected to continue into future years because of the better starting point, with receipts "higher across all major taxes other than those related to energy" and fiscal drag delivering "stronger growth in key tax bases."
The Chancellor has chosen to use two-thirds of the borrowing improvement to pay for extending the fuel duty freeze, new business tax breaks and extending childcare subsidies.
However, it still means public borrowing falls to 1.7pc of GDP in 2027-28, meeting a fiscal target of keeping borrowing below 3pc of GDP by a wide margin.
The Chancellor also meets another goal to get Britain's debt share falling by the end of the forecast, but only by a "vanishingly small" margin, according to Mr Hughes at the OBR.
Debt falls from 94.8pc of GDP to 94.6pc of GDP in 2027-28. In cash terms today, this is just £6.5bn, by far the "smallest amount of headroom any Chancellor has set aside against his primary fiscal target, which has averaged £25.6bn in today’s terms since the OBR was established in 2010", the fiscal watchdog said.
This headroom could easily be wiped out by a jump in gilt yields, which Mr Hughes said had been "very volatile" over the last three months.
A one percentage point move up or down would mean Mr Hunt no longer met his already loose fiscal rules, the OBR said. The OBR also questioned the "deliverability of the policies in this Budget".
It said the £4bn it had pencilled in "from the Government’s stated, but rarely implemented, policy of raising fuel duty rates in line with RPI inflation every year, plus the reversal of the temporary 5p cut that is now in its second year" was crucial to the Government meeting its fiscal rules given the limited headroom.
"Cancelling these planned increases, as every Chancellor has done since 2011, and instead holding fuel duty at its current rate would, in itself, more than halve the Chancellor’s headroom," it said.
House Prices
House prices are expected to fall 10pc over the next two years as a jump in mortgage rates puts an end to the pandemic property boom.
Transactions are expected to drop by a fifth, reducing tax revenues from stamp duty by £5bn next year alone.
The drop is spread over two years due to 80pc of households being on fixed-term loans, up from less than 50pc before the financial crisis. This means the blow of recent interest rate rises will take years to flow through the housing market, according to the OBR.
By 2027, the average interest rate on outstanding home loans will hit 4.2pc – more than double the low of 2pc recorded in 2021.
The OBR downgraded its house price forecasts despite the fact that the outlook for mortgage rates and the economy has improved.
Back in November, the OBR had forecast that the average interest rate on Britain’s outstanding mortgages would peak at 5pc.
While it now expects average rates to settle, the OBR added: "low consumer confidence, the squeeze on real incomes, and the expectation of mortgage rate rises to come are expected to contribute to continued falls in house prices and a reduction in housing market activity."
