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Economy to regain pre-Covid peak at year-end, but inflation clouds outlook – OBR

By PA News

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Britain’s economy will recover to its pre-pandemic level faster than expected, but soaring prices could see inflation hit its highest rate for three decades, according to the UK fiscal watchdog.

The Office for Budget Responsibility (OBR) said it now believes the economy will return to its pre-Covid level at the “turn of the year” – around six months earlier than predicted in March – as it delivered a raft of economic upgrades.

Officials also revealed the Chancellor has now raised taxes more in a single year than since 1993 in the aftermath of Black Wednesday as he tries to balance the books.

This equates to a net tax rise of £16.7 billion by 2026/27 which takes into account some falling taxes and the freeze in fuel duty.

The OBR also predicted long-term scarring effects of coronavirus on the economy have also been scaled back by the independent forecaster, which has revised it down from 3% to 2%.

(PA Graphics)
(PA Graphics)

But the OBR figures also revealed pain in store for household and public finances from soaring inflation, with the latest prediction showing the rate of Consumer Prices Index (CPI) is set to jump from 3.1% to an average of 4% over 2022.

It warned that news since its report was compiled suggested a peak of close to 5% in 2022 and the possibility of inflation hitting its highest rate for 30 years.

Building supply chain woes and surging energy costs in the UK and globally are also holding back growth, with the OBR saying this has already seen the pace of recovery slow in recent months.

“We expect the pace of growth to continue moderating over the remainder of the year and into next, as supply bottlenecks persist, fiscal support… is withdrawn, and the colder weather drives up coronavirus case numbers and other seasonal infections,” the OBR said.

(PA Graphics)
(PA Graphics)

Officials also said there were concerns that unemployment could rise temporarily with the end of the furlough scheme and that older workers could retire early, potentially reducing productivity.

With speculation mounting that the Bank of England may have to act as soon as next month to control rocketing prices, the Chancellor warned that even a one percentage point increase in interest rates would cost the country £23 billion in payments on its debt mountain.

But Rishi Sunak has been offered some welcome room to manoeuvre as rebounding growth means the OBR now sees borrowing falling consistently from last year’s peacetime record.

The OBR is now forecasting that gross domestic product (GDP) will grow by 6.5% in 2021, up sharply from the 4% predicted in March.

Next year’s GDP outlook has been downgraded to 6% from 7.3% forecast in March, though the OBR has upgraded its forecast for 2023 to 2.1% from 1.7%, with expansion now expected at 1.3% in 2024 and 1.6% in 2025.

(PA Graphics)
(PA Graphics)

The bounceback and enormous furlough support is also helping the UK jobs market weather the pandemic, with the OBR now expecting the unemployment rate to peak at 5.2%, down from 5.6% previously and the 12% initially feared.

Mr Sunak outlined a raft of new fiscal rules, called the Charter for Budget Responsibility, which will look to ensure day-to-day spending is no longer funded via borrowing and for underlying debt – currently around 100% of GDP – to fall.

The OBR said the improved fiscal outlook means the Chancellor is on track to meet his new goal for underlying debt to fall by 2024-25.

(PA Graphics)
(PA Graphics)

This is thanks to sharply lower borrowing expected in each year under the forecasts, with the OBR now saying it believes borrowing will drop to £183 billion or 7.9% of GDP in 2021-22, down from the 10.3% or £234 billion previously predicted and almost half the record £320 billion amassed in 2020-21 after a mammoth £315 billion of emergency pandemic support.

Borrowing will then drop to £83 billion or 3.3% of GDP next year, then decline gradually to 2.4%, 1.7% and 1.7% in the following years before reaching £44 billion or 1.5% in 2026-27.

This would leave borrowing at the forecast horizon 1% of GDP lower than it was before the pandemic struck, and the lowest level for 25 years, according to the OBR.

Jonathan Gillham, chief economist at PwC, said: “This rapid recovery must be viewed through the lens of inflation which is largely being “imported” from overseas.”

He added: “The key risk to the recovery is polarisation. Some households are benefiting from rapid earnings growth some are not, the UK’s economic geography in the Chancellor’s words is “uneven”, some industrial sectors are recovering more quickly than others.

“If the households and businesses that are not able to share as much in the upgraded recovery projections are pushed under by rising inflation, this could slow the recovery.”

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