The Chancellor’s Spending Review

George Osborne spent his first years as Chancellor dealing with disappointments – both on the UK economy and the state of the public finances. In his latest Autumn Statement he finally had some good news to play with, in the form of more upbeat revenue forecasts from the Office for Budget Responsibility (OBR). He took full advantage of this extra room for manoeuvre, cancelling planned cuts to working tax credits and easing the squeeze on public services over the next five years.

There was also more money for public investments in infrastructure. But his plans for a £10bn budget surplus by 2020 still involve eye-watering cuts for some government departments and they look ambitious against a backdrop of subdued global growth.

This was the first combined Spending Review and Autumn Statement since 2007 and comes less than four months after the July Budget. The OBR's forecasts for the economy have not changed much since then. But it has revised up its forecasts for future tax revenues and revised down the medium-term forecast for interest rates – which means lower debt servicing costs for the Treasury.

The net result of these changes would have been to push forecast borrowing down by several billion pounds a year over the next three years. But the deficit forecasts do not reflect this, because Osborne has used the extra cash to loosen policy in other areas – notably in the decision to give up cutting tax credits for working households by nearly £4bn a year.

Taking all the announced changes together, the Chancellor has delivered a net fiscal 'giveaway' of £6.2bn in 2016-17, but just under half of that will be offset by the rosier OBR forecasts. The deficit is now forecast to be £49.9bn in 2016-17, £3.3bn higher than expected in July but still well below the £73.5bn forecast for 2015-16, which is the equivalent of 3.9 per cent of GDP.

Borrowing in 2017-18 and 2018-19 will be modestly higher than previously forecast, on a like-for-like basis. But the forecasts still show a modest £10.1bn (0.6 per cent of GDP) budget surplus in 2019-20, the last year of the current parliament.

There are some tax increases, which will not be popular in some quarters, including an 'apprenticeship levy' on employers that will raise nearly £3bn a year by the end of the parliament, and an additional 3 per cent in stamp duty on buy-to-let properties and second homes, which comes into force in April 2016 and is forecast to raise £825m a year by 2019-20.

Business groups may also be concerned to see the Department for Business and the Department for Transport bearing the brunt of the spending cuts. Spending in these areas will fall by 17 per cent and 37 per cent respectively by 2019-20. The Department for Energy and Climate Change is another big loser, with an overall cut in spending of 22 per cent.

Taking the new extra stamp duty along with the partial removal of interest deductibility in the July Budget, the buy-to-let sector has not been treated kindly by the Chancellor since the general election. But after so many years of highly favourable tax treatment, this shift is not entirely unexpected and could have positive consequences for the investment industry if it encourages households to put their savings elsewhere.

Investor Implications

Market response was muted. The sterling-dollar exchange rate saw an intraday move of 0.4 per cent, with the pound strengthening as the Chancellor spoke. Ten-year Gilt yields bumped up from 1.860 per cent at the market open to 1.875 per cent, and the FTSE 100 remained unchanged.

This subdued reaction is not surprising, given that the basic macroeconomic fundamentals for the UK have not changed significantly as a result of this Autumn Statement.

Fiscal policy will be slightly looser in 2016 than previously thought, which could be positive for economic growth. But such effects are small relative to the potential impact on the UK of global economic factors, as well as any rise in official interest rates.

Financial markets are currently forecasting little or no change in monetary policy in the UK in 2016. We think that could change if the US central bank goes ahead with a first rate rise in December. But today's announcements will not have done much to change that calculation. They will confirm George Osborne's reputation as a chancellor who is willing to bend with the wind – both for economic reasons and for political ones.