Fiscal goals hinge on optimistic growth outlook

LONDON Thu Mar 24, 2011 4:18pm GMT

1 of 17. Chancellor of the Exchequer, George Osborne, addressing the House of Commons as he presents the Budget, March 23, 2011.

Credit: Reuters/Parbul TV via Reuters TV

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LONDON (Reuters) - Britain is dependent on what may be over-optimistic forecasts of strong growth in 2013 and 2014 to meet deficit-reduction targets needed to keep its triple-A credit rating, analysts said on Thursday.

Chancellor George Osborne's 2011 budget on Wednesday contained a downgrade to growth forecasts for this year and next. This puts a greater onus on an economic rebound from 2013 onwards for his coalition to eliminate the budget deficit before the 2015 national election.

Ratings agency Moody's said on Thursday that it was keeping a close eye on the growth outlook following the budget changes.

"Slower growth combined with weaker-than-expected fiscal consolidation could cause the UK's debt metrics to deteriorate to a point that would be inconsistent with an AAA rating," it said in a statement.

Ratings agency Fitch made a similar point in a note late on Wednesday.

Preserving the triple-A sovereign debt rating that Britain enjoys from the major ratings agencies is a top economic priority for the coalition, which inherited a deficit greater than 10 percent of gross domestic product.

Osborne's fiscal plans are heavily constrained by forecasts from the Office for Budget Responsibility, an independent government body that provides macroeconomic and fiscal forecasts and is given advance notice of tax and spending changes.

On Wednesday it cut its growth forecasts for 2011 and 2012, with the 2011 growth forecast falling to 1.7 percent from 2.1 percent estimated last November. A Reuters poll earlier this month forecast growth this year at 1.6 percent versus a February forecast of 1.7 percent.

However, Osborne also raised growth forecasts for 2014 and 2015 to just under 3 percent, at the top end of pre-crisis estimates of Britain's long-term sustainable rate of economic growth.

"Questions remain over the OBR's growth projections, which many, including us, think are still too optimistic," said David Owen, chief European financial economist at investment bank Jefferies.

In a briefing to economists on Thursday, the OBR defended its strong forecasts for later in the cycle by saying that it expected household consumption to pick up as inflation fell and wage growth returned to levels of around 4 percent.

However, it acknowledged its predictions were vulnerable to further rises in oil prices, which a Reuters poll shows are expected to stay above $100 a barrel through 2013.

"Forecasting oil prices is an absolute mug's game," said Stephen Nickell, a member of the OBR's main steering committee.


The Institute for Fiscal Studies, an academic budget analysis body, said that underlying the OBR's forecasts was also an assumption that slower growth this year and next is primarily cyclical, and will easily be made up in future years.

"Given these forecasts it is clear why the chancellor, sticking to his plans, did not feel able to engage in a net giveaway," IFS Director Paul Johnson said.

"Going forward he is going to be uncomfortably dependent on the judgments that the independent OBR makes over the unobservable potential output of the economy."

Academics at the National Institute of Economic and Social Research also said the OBR forecasts looked too optimistic -- especially regarding consumer spending -- in testimony to legislators on Thursday about the budget.

Inflation poses a risk to Britain's longer-term fiscal outlook too, as it pushes up social security costs and the expense of servicing the swelling number of inflation-linked government bonds.

The IFS said it would also make public spending cuts harder.

"Simply because inflation is turning out higher than expected, real cuts to public service spending are now on course to be, on average, one percentage point greater over the next four years than was announced in the (October) spending review," Johnson said.

The OBR assumes that inflation will return firmly to its 2 percent target and remain there from 2013 onwards, at the same time as annual GDP growth hovers just below 3 percent.

But Bank chief economist Spencer Dale, in a speech early on Thursday, warned there was a danger that a long recent run of above-target inflation could be damaging the bank's credibility, making it harder to keep prices in check.

(Additional reporting by Christina Fincher; editing by Stephen Nisbet)