A mere 285 days into the job, Rishi Sunak made yet more history on Wednesday for reasons he could have barely imagined when he became chancellor in February.
Inevitably, a record peacetime deficit of £394bn is a headline-stealer, but one side-effect of the coronavirus crisis is that these astronomical numbers have almost lost their power to shock. Who in truth could claim to be surprised when the state has been supporting more than a third of the workforce, to a greater or lesser extent, since March?
Sunak has wisely opted to support the economy throughout the next year: but rather than worry, for now at least, about the alarming deficit figures, we should pay more heed to the Office for Budget Responsibility’s verdict on the longer-term scars left by the virus.
The extent of this damage will be a key determinant of how quickly we can pay off the pandemic’s vast bills.
Here the news is not good. The economy has a nasty case of long Covid.
The OBR has the economy 3pc smaller in 2025 as a result of the pandemic, meaning permanent damage of more than £60bn.
Despite prospects for consumers looking healthier as more fortunate households splash out enforced savings, business investment has stalled and remains more than 20pc below the end of 2019.
Even before Covid, uncertainty since the Brexit referendum had seen business spending flatlining since 2016. That resultant capital shallowing from years of under-spending has already left its mark on our economy’s productive capacity - and things will go further downhill from here.
Even though a resolution with the European Union - whether through deal or no deal - will at least lift the uncertainty facing businesses, the OBR now expects cumulative business investment over the next five years to be 10pc lower than predicted in March, reflecting the fact that “while uncertainty recedes, it does not dissipate altogether”.
It argues that post-Covid doubts over potential changes in working patterns, such as higher rates of working from home and lasting changes in consumer preferences, are likely to prompt businesses to press pause until the picture becomes clearer.
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The verdict echoes the warnings from those such as Bank of England rate-setter Michael Saunders, who told MPs this week that he expects a post-pandemic “hangover” among UK firms. Higher Covid-19 debts, plus a desire to hold bigger buffers against future black swan events, is likely to stymie spending ambitions for the near future at least.
In the fiscal watchdog’s view, the UK’s potential growth is lower due to the productivity hit in the short term through firms having to adapt to Covid-secure measures, giving way to the longer term blow from the fall in business investment.
The productivity blow is worsened by other supply-side factors such as the pandemic’s hit to migration flows, the earlier retirement of some workers and a higher level of structural unemployment.
This has two consequences. Firstly, it means more ground to be made up through the structural deficit. It is impervious to the rise and fall of the economy, and something which Sunak will eventually need to address.
The OBR puts the size of this hole in its central forecast and downside scenario at between £21bn and £46bn - or between 0.8 and 1.8pc of GDP - which will have to be filled by either tax rises or spending cuts just to keep debt stable as a share of GDP.
Some economists warn this is too optimistic. At least unemployment will not be as high as the 12pc shocker of a forecast the watchdog produced in July, thanks to the extended furlough and the emergence of vaccines.
But the second consequence of lower potential growth means a lower “speed limit” for the economy. In theory that means the Bank of England has less room to stimulate the economy before inflation worries surface in Threadneedle Street.
In practice, inflation is the least of the Bank’s worries - rather the opposite - and it will be hoovering up most of the Chancellor’s newly minted gilts throughout most of 2021. But the Bank will not be there to prop up the Treasury forever, and the watchdog is alert to the threat of rising interest bills for the Government’s swollen debt pile.
Even though the cost of servicing the mountain is predicted to hit a new record low of just 1.7pc, the maturity of the debt has shortened, making our debts twice as sensitive to the vagaries of the market. The trend “has increased the vulnerability of the public finances to future economic shocks, in particular to a sharp increase in short-term interest rates”. The cost of a single percentage point rise in short rates has doubled from £6bn to £12bn.
Like any set of forecasts, the only certainty about the OBR’s fiscal predictions is they will be wrong, this year more than any other. But the direction of travel points to a reckoning ahead for the Chancellor, who pulled his punches on a public sector pay freeze today.
Beyond today’s largesse, the key question for 2021 is how far he dares to go in repairing the damage and returning the public finances to sustainability.
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