OBR paints brighter picture for UK economy

The UK has fought off the threat of a post-Covid surge in unemployment, with the jobless rate set to peak well below the level reached after the 2008 financial crisis, official forecasts show.

The Office for Budget Responsibility now expects a further half a million people to fall out of work over the course of the year, with unemployment peaking at 6.5 per cent at the end of this year.

This is both lower and later than the 7.5 per cent peak the fiscal watchdog had forecast in November — and well below the 8.5 per cent unemployment rate reached in 2011, in the wake of the last recession. Further out, its projections show unemployment falling to 4.4 per cent, close to its pre-pandemic low, by 2025.

The OBR, which published the economic forecasts underpinning the Budget on Wednesday, said the improved outlook for the labour market was partly down to the latest extension of the furlough scheme, with wage subsidies set to continue until the end of September.

It also reflected the OBR’s hope that the rollout of vaccines and the chancellor’s injection of fresh fiscal stimulus — in particular, the temporary tax break for business investment — would fuel “a swifter and more sustained economic recovery, albeit from a more challenging starting point than we forecast in November”.

The OBR now expects the UK economy to regain its pre-pandemic size in the third quarter of 2022, six months earlier than it forecast in November. It has cut its forecast for GDP growth in 2021 to 4 per cent, reflecting the effects of the first-quarter lockdown. But it expects a rapid rebound as restrictions lift later this year, with growth in output of 7.3 per cent in 2022.

Richard Hughes, the OBR’s chairman, said the rebound would be driven by consumers as the economy reopened and households spent the savings they had built up. The other main driver would be businesses bringing forward investment to take advantage of the temporary “super-deductions” on capital investment announced by chancellor Rishi Sunak.

However, some economists warned these forecasts could prove optimistic, with the looming rise in corporation tax weighing on business investment and little further policy support for employment or household incomes once emergency support came to an end.

Carys Roberts, executive director of IPPR, the think-tank, said the OBR’s scenario was a “rosy view” that ignored the losses many households and businesses had sustained. It meant the chancellor was “betting on a ‘trickle down’ recovery led by high earners and big businesses,” she added.

The OBR’s forecasts suggest that even if mass job losses are avoided, a weak labour market and the shaky state of corporate balance sheets would hold back wage growth even when the economy starts to recover. As a result, labour’s share of income would fall, leaving average earnings 6 per cent below their pre-pandemic trajectory by 2025.

The Resolution Foundation think-tank noted that Sunak’s decision to end a temporary uplift in benefits payments in November would cut income for the poorest just as unemployment neared its peak. It said that by focusing so much of the recovery support on business investment, the chancellor was “gambling” that household consumption would “recovery strongly without further support”.

Scott Corfe, research director at the Social Market Foundation, warned that while the peak in unemployment was far lower than had been feared earlier in the crisis, it “could stay higher for longer” with the rise of remote working and online retail.

Despite the better near-term outlook, the OBR has made no change to its estimate of the lasting damage the pandemic has dealt the UK economy, with GDP set to remain 3 per cent below its pre-pandemic trend in 2025.

This is partly because it expects business investment to slow sharply once the tax break expires — with total investment over the five-year period of the forecast well below its pre-pandemic trend.

Rain Newton-Smith, chief economist at the CBI business group, echoed doubts over the long-term effect of the measure, saying there would be a “sharp intake of breath” among businesses in 2023, when the super-deduction ended just as the increase in corporation tax took effect.

Karen Ward, strategist at JPMorgan Asset Management, also questioned whether the tax break would achieve its ends. “Historically incentives haven’t had much impact on spurring spending, since the outlook for demand tends to be the primary driver. But if demand does recovery strongly it may tip the balance for some firms,” she said.

The other factor limiting the UK’s growth prospects is the likelihood that an exodus of foreign-born nationals during the pandemic would mean a smaller UK workforce. The OBR said recent labour market data suggested the population was “substantially smaller” than official statistics showed and could, in the worst case, be up to 2 per cent smaller in the longer term.

Charlie Bean, an OBR committee member, said the watchdog’s estimates of medium-term economic scarring remained highly uncertain, since the pandemic was “very unlike any other shock that the economy has gone through in the past”. 

In a more optimistic scenario, where effective lockdown measures and rapid vaccination brought infections under control more rapidly, the OBR said output could regain its pre-pandemic level by the middle of this year, with no lasting scarring. But in a downside scenario, with a further wave of infections next winter, GDP might regain pre-pandemic levels only in 2024 and remain 6 per cent lower than its previous trend in 2025.

One source of uncertainty has lessened, however. The OBR said the terms of the Brexit deal were broadly similar to its previous assumption of a typical free trade agreement. This would leave UK productivity 4 per cent lower in the long run than if Britain had remained in the EU.

FT economics editor Chris Giles’ 2-minute Budget summary

Rishi Sunak’s second Budget was a spend now, tax later affair. Record support for the economy during the pandemic will be replaced by the largest tax increases in a generation by 2023. The chancellor hopes the economy will bounce back and ride this rollercoaster in style.

A Budget of two halves

• Another £65bn of support to tackle effects of coronavirus

• Covid-19 support measures continue until at least September

• Sunak faced with a £37bn hole in the public finances in 2025-26

• He addresses this with £32bn of tax rises and £4bn of public spending cuts

Key economic numbers

3%

Persistent hit to the economy from coronavirus

4%

Economic growth in 2021

10%

Budget deficit in 2021-22

Pandemic support extended

The extra pandemic support

£7bn

Cost of extending the furlough scheme for six months

£13bn

The amount due to be spent on the self-employed

£17bn

Business support measures will cost even more in the near term

Corporate tax hike

• Corporate tax rate rising from 19% to 25% in 2023

• A new ‘super-deduction’ to boost investment in 2021 and 2022

• Least profitable companies keep the 19% rate

• UK corporate tax revenues rise above the international average

Personal finance

£12,570

The personal allowance frozen at this level until 2025-26

£50,270

Threshold for higher-rate tax also frozen for four years

£8bn

Revenues expected every year from income tax increases

Building a new economy