Devils In The Detail

27/11/2015 at 4:59 pm

So another Autumn Statement has been and gone. As is now traditional the Chancellor tried to lift the mood by repeating some of the more substantial announcements made in his previous set-piece appearances. But there were changes too. Most significant among these was the U-turn on tax credit reform, which would have hit the incomes of low earners hard (for those who have not yet seen the headlines the BBC’s “key points” summary is as good a place to look as any). It was widely and accurately reported that this had become affordable due to improvements in the OBR’s forecasts for the British economy, delivering £27bn of extra pie in the fiscal sky between now and the end of the current parliament.

As usual, there was a gap between spin and reality on the matter. In his speech to the Commons, Mr Osborne attributed his windfall as follows:

“This improvement in the nation’s finances is due to two things. First, the OBR expects tax receipts to be stronger. A sign that our economy is healthier than thought. Second, debt interest payments are expected to be lower – reflecting the further fall in the rates we pay to our creditors.”

Higher tax receipts can indeed signify economic growth. The OBR’s growth forecasts, however, haven’t changed much. In a rather lower-profile address given by Robert Chote, OBR Chairman, he gave the following additional information on this topic:

“[T]he underlying fiscal position looks somewhat stronger over the medium term than it did in July, before you take into account the Autumn Statement measures. This in part reflects the recent strength of income tax and corporation tax. But it also reflects better modelling of National Insurance Contributions and a correction to the modelling of VAT deductions.”

Ah.

In fact, looking at the data presented at Mr Chote’s press conference, the impact of these modelling changes tots up to +£12.6bn over the five fiscal years to 2019-20.

Now let’s look at the rates demanded by those creditors. Here is how the forecasts for the UK’s central government gross debt interest have changed since the summer:

Summer Budget Autumn Statement
Fiscal Year £bn £bn
2015-16 46.7 46.5
2016-17 51.1 51.0
2017-18 55.9 54.2
2018-19 57.2 55.7
2019-20 58.5 57.3
TOTAL 269.4 264.7

 

£4.7bn out of such large totals is not a huge amount (less than 2% in fact), but in policy terms it is material, equivalent to the entire cost between now and 2020 of increasing the personal allowance to £11,000, the single biggest giveaway of the last Budget.

Underlying the relatively modest reduction in the projected cost of debt interest is a similarly modest reduction in projected gilt yields. The OBR data for these is scrambled between different documents for the Budget and Autumn Statement, which possibly explains why no media source appears to have covered it. But the point is that the average market interest rate assumption for the next five years has fallen all of 0.4% since July, from 2.7% to 2.3%. It is on such details that material elements of this country’s fiscal policy now have to be based.

Of course movements in gilt yields have not always been modest. And what ought to concern us is the extent to which they will impact the exchequer should they begin to rise again over coming quarters. Two short years ago – before cheap oil abolished inflation – the ten year gilt yield stood a full 1% higher at 2.8% as against 1.8% today. The Autumn Statement of 2013 put average interest rates for 2015-2019 at 3.8%. What would a forecast change of +100bp do the £4.7bn bonanza secured by a change of -40bp? A proportionate adjustment would wipe out £12bn at a stroke – exactly the amount of the extra spending on defence announced by the Prime Minister on Monday (to be spread over the next ten years.)

Look further back and the message is equally clear. The first half of 2011 was not exactly the cheeriest of times: Greece was collapsing, emergency monetary measures were in full swing and panic was pushing gold to record highs. Still the ten year gilt yielded more than 3.8% for much of the time. And in the years before the credit crunch began to bite the average was about 4.5%.

Neither is the cost of debt linked entirely to interest rates: there is inflation to consider as well. Of the UK’s £1.5trn nominal value of outstanding debt, over £300bn nominal is index-linked to RPI. Since July the OBR’s RPI inflation assumption has been cut by 0.2%; the average for the next five years is down to 2.4% from 3.1% a year ago. And talking of inflation, the CPI measure – which now governs increases to pensions and other benefits – has also seen forecast falls since the summer. The OBR’s average for the next five years is 0.5% lower now than it was last year, 1.3% versus 1.8%.

But then again, who really is talking of inflation? Not the Chancellor. Neither the word nor the concept made a single appearance in his speech on Wednesday. Still, Mr Chote had something to say:

“[W]e still expect inflation to kick up over the coming year as favourable base effects drop out. We expect it to rise slightly more quickly than in July thanks to greater pressure from unit labour costs.”

Something to think about there, possibly.

In summary the Autumn Statement carried an element of political drama but the macroeconomic substance remained hidden away – when it was not being positively spun, that is. Mr Osborne seems to have a rare knack for making political capital from fiscal policy, rather like his predecessor Mr Brown. But the evolution of the country’s debt position and the official forecasts on which policy is based have relatively little to do with him and much more to do with interest rates (and inflation).

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