Autumn Statement: Reaction

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“All models are wrong, but some are useful”. This quote from British statistician, George Box, has taken on added resonance for the UK economy in recent months. Economic models have moved from the periphery of economic debate to the centre in just under two months. It has been a breathless transformation. Yesterday’s Autumn Statement was accompanied by plenty of big numbers derived out of models used by the Office for Budget Responsibility (OBR). Despite the inclusion of these numbers in glossy documentation and with their detailed explanation, the OBR’s modelling of future economic conditions will inevitably be wrong. But make no mistake, despite this apparent deficiency, the modelling by the OBR is also very useful. Its use is not just confined to journalists and economists seeking to make sense of the government’s financial plans. It matters for the price of our mortgages, the interest rate on our credit cards, the value of the pound and the affordability of public services.

The value of modelling economic decisions was starkly illustrated when the OBR was side-lined from performing this role for former Chancellor, Kwasi Kwarteng, and his Mini Budget in September. Investors both domestically and abroad looked at this decision and questioned what the UK government was trying to hide. The result was a sharp rise in the cost of UK government borrowing, higher interest rates for households and businesses, and a weaker Pound. Ultimately it was this reaction by financial markets that cost Kwarteng and former Prime Minister, Liz Truss, their jobs. History never allows for a re-run, but there is a decent chance that if the OBR had been included in evaluating the Mini Budget the reaction on financial markets would have been less dramatic. Some of the tax increases and spending cuts announced at the Autumn Statement could have been avoided.

Now firmly back in the fold the OBR actually produced a rather more upbeat forecast for the UK economy than the Bank of England did just two weeks ago. The OBR see the UK economy now at the start of a five-quarter recession, rather than one lasting eight quarters as seen by the Bank of England. By the end of 2025 the OBR expect the UK economy to be around 4% larger than the Bank of England. This is a big difference. The government of the 2025 had better hope that the OBR is right – and the Bank of England is wrong – else the painful decisions unveiled at the Autumn Statement will be just the start.

There appear to be three key judgements from the OBR that are driving this difference. Firstly, the OBR are more confident than the Bank of England that some of the excess savings built up by UK households during the pandemic – worth around £250 billion but concentrated amongst affluent households – will be spent during the coming recession. As household grapple with the rising cost-of-living this propensity to lean-in will be crucial. That this will happen is, however, far from certain. In previous economic downturns in 1990, and again in 2008 UK households responded by saving more.

Secondly, the OBR are assuming higher inward migration boosts the size of the UK economy. Again, this is a contentious assumption but not because of its impact on growth, but rather that recent migrant flows have been very sensitive to Brexit and the disruption caused by the pandemic. It is far from clear how flows will evolve in the coming few years. Finally, the OBR have had the luxury of two more weeks to fine tune their forecast than the Bank of England. Normally this would make little difference, but such has been the fast-moving nature of UK interest rates and global energy prices – both of which have fallen sharply recently – the OBR have been able to take a more constructive stance on the impact these will have on household incomes.

And this brings us back to the function of economic forecasts. They frame expectations, shape decisions and signal that the economic decisions – that affect all aspects of our lives – are subject to scrutiny. Chancellor Jeremy Hunt comes across as someone who understands this role. As a result, financial markets are prepared to be more understanding of the difficult path he now must tread.

Simon French

Managing Director, Head of Research

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