Office of Budget Responsibility the winner of this week’s ‘Order of the Brown Nose’ – comment by Stuart Thomson, chief economist at Ignis Asset Management
“The Office of Budget Responsibility has published its first set of economic and fiscal forecasts and we are disappointed by the results. The economic forecasts that will form the basis of Chancellor George Osborne’s emergency budget presentation next Tuesday are the newest version of the most plausibly optimistic forecasts. The previous Treasury forecasts have been roundly condemned as too optimistic and a downward revision to the provisions was inevitable.
“The OBR has lowered both current and potential growth forecasts, with the estimate of productive potential lowered from the Treasury’s miraculous 2.75%, down to the economy’s long-term average of 2.25%. The OBR has assumed a further decline to 2.0% by 2014 due to the aging population.
“It would be churlish to criticise the OBR’s first efforts in view of the lack of detail provided by the government on the areas where the fiscal spending axe will fall – this will have an important impact on how the economy responds to the fiscal tightening. The Institute of Fiscal Studies estimates that in the wake of the OBR report the government will still have to find an additional £34bn per year worth of savings to bring the deficit back below the 3% Maastricht limit by the end of parliament. The OBR will undoubtedly have a marked impact on fiscal policy formation in the future and we believe that it is an important additional to the political and economic landscape, despite its inauspicious start. Indeed, it would be dangerous to throw out the baby with the bathwater. We believe that the OBR’s scenario of an investment led recovery will eventually prove prescient, but the path of true investment booms does not run smooth and we believe that economic activity will be depressed by fiscal austerity. This will force the Bank to resume quantitative easing on a massive scale. The result being the marked decline in long dated forward interest rates which is necessary to trigger this investment renaissance.
“The optimism expressed by the OBR shifts the focus back onto next week’s emergency budget. We continue to believe that this presentation will be bullish for long-dated forward gilt rates by exceeding expectations of tightening and lowering gross gilt sales in the current fiscal year to £165bn. Sterling has benefitted from the rebound in risk appetite over the past week. It is under-valued on a fair value basis with potential to outperform during periods of rising risk appetite. With the coalition government determined to maintain Britain’s membership of the dwindling group of triple AAA rated countries, the currency should continue to attract strong overseas demand for both currency and government debt. However, we believe that this view has to be tempered by our expectation that risk appetite will diminish in the second half of the year as the global economy slows from its inventory-led peak in the summer. This suggests that Sterling’s performance will be greater against the Euro and commodity currencies than the US dollar during this period.”
These are the views of the author and do not necessarily reflect those of Ignis Asset Management.