Weekly Update – UK economy starts contracting as we look ahead to next week

Data published this morning confirmed what had been looking likely for a while – the UK economy shrank over the course of Q3. This is likely to be the first quarter of a recession, and if the Bank of England’s forecasts from last week are correct, it will last for the next 2 years and be the longest recession since records began.

The economy shrank by 0.2% in Q3, driven by a decline in manufacturing activity. In addition, consumer facing services also fared badly, as the cost crisis squeezes household budgets. In September specifically, the economy shrank by 0.6%, driven – in part at least – by the extra Bank Holiday for the Queen’s funeral putting a dampener on economic activity.

Budget transparency leaves a lot to be desired

Last week there was extensive coverage of the Scottish Government’s Emergency budget review, which we covered in a blog. The Deputy First Minister set out the challenges the Scottish Government have given the increasing upward pressure on public sector pay and the desire to channel money to cost if living measures.

One of the main headlines was the decision to set out cuts to health services – including social care, primary care and mental health services – in order to fund a pay deal for many NHS staff. What has become clear since, at least for the nursing profession, is that the pay deals currently on offer are unlikely to be sufficient to avoid industrial action.

To a certain extent, the presentation of the funding for the pay deals is designed to put pressure on the Unions and staff involved – by making it clear that money will not be found outwith the health budget for these deals.

A significant proportion of the budget cuts announced by the DFM were in capital spending projects or financial transactions. Normally, these funds would not be able to be diverted to resource spending which is the issue here when we’re talking about pay deals. So either additional flexibilities have been given to the Scottish Government to use the funding for resource spending (which hasn’t been set out in the EBR, so we’re not sure) or… the capital spending cuts aren’t really relevant to a discussion about finding resource budget in year to help deal with pay deals.

Alongside the EBR, there was also the Autumn Budget Revision (ABR) which was laid in parliament last Tuesday. This is one of two opportunities (along with the Spring Budget Revision) that the Scottish Government has to amend their Budget bill that was passed before the start of the financial year.

The ABR has a lot of tables in it, and is pretty impenetrable, even for folks like us who spend too much of our lives looking at fiscal tables. Normally, the SG send a guide document to the ABR to the Finance Committee which helps analysts like us understand what is going on. Unfortunately that hasn’t been sent yet, and we understand it is due on Monday. Really, though, the SG should publish this alongside the ABR being laid.

One thing that we’re struggling with a bit is reconciling the story told by the ABR in contrast to the EBR. What the ABR shows is, compared to when the budget was set out in December, that there were £460m extra consequentials, and more than expected in the reserve (although there is not detail on how much there is extra and why). It’s therefore difficult to understand why the level of cuts that the DFM has set out are necessary to meet the expected level of additional funding for pay deals. We look forward to seeing the additional info from the Government – perhaps all will become clear.

EBR, ABR – now for the OBR

All eyes will be on Jeremy Hunt for one of the most hotly anticipated fiscal statements of recent times next Thursday. The Chancellor’s statement is expected around 12.30, and will be accompanied by a full set of forecasts from the Office for Budget Responsibility (OBR).

So what will we be looking out for?

It will be really interesting to see what the OBR’s view will be on the outlook for the UK economy given the difficult period we are entering – and how similar or different it is to the view of the Bank of England. The pathway for inflation will also be one of the first things we look at – again compared to the Bank, in terms of how long it may take for inflation to get back towards target.

Still on inflation, we’ll be examining what the OBR’s view is likely to be on the Government’s intervention on energy prices after April. The Bank assumed that the intervention for households will continue to hold the price down and therefore impact on measured inflation, but if the Government switch to transfers to the most vulnerable households then it is likely that ONS will not treat that as a price discount, in line with how they treated the £400 transfer to households. Therefore the assumption that inflation will peak around now may not bear out in reality.

The pathway for Government spending – particularly departmental spending – will also be set out by the Chancellor on Thursday. Depending on the areas where any cuts fall, it will determine the consequentials (positive or negative) that may affect the Scottish Budget envelope.

Closer to home, we’ll be having a look at the OBR’s assumptions on Scottish devolved taxes – while it is the Scottish Fiscal Commission’s forecast alongside the Scottish Budget that matters for (e.g.) income tax, the OBR’s forecast feeds into the “rest of UK” figure that is used to calculate the Block Grant Adjustment. For the uninitiated, this is the amount deducted off the Block Grant to reflect the fact that certain taxes are now devolved.

Look out for all our analysis on Thursday!