OBRituary

Yesterday, the Office for Budget Responsibility (OBR) released their ‘fiscal risks and sustainability’ report which looks at long-term economic trends and risks for the Nation’s growth and finances along with analysing sensitivities to changes in key demographic and macroeconomic assumptions.

The report identified a series of long-term pressures faced by the UK economy, including an ageing population, climate change, and rising geopolitical tensions.

According to the report’s base case scenario, national debt is forecast to rise to 274% of GDP in 2071, up from just under 100% today. Here, the report identified that “to return debt to its pre-pandemic levels would require an average fiscal tightening of 1.5 per cent of GDP per decade over the next 50 years”.

However, with government spending projected to increase from 45% to over 60% of GDP over the fifty-year period, tax revenues are estimated to stay more or less unchanged at 40% of GDP.

The forecasted rise in spending alongside a stall in tax revenues (in percentage terms), suggests that the UK’s current financial trajectory is unsustainable, with the possibility of debt spiralling out of control if left unchecked.

One remedy is to increase productivity. For example, the OBR maintain that “with every 0.1 per cent increase in productivity growth reducing the rise in the debt-to-GDP ratio by 25 percentage points. A full 1 percentage point increase, equivalent to a return to pre-financial crisis rates of productivity growth, could keep debt below 100 per cent of GDP throughout the next 50 years.”

While the report has been the topic of heated political debate – not least given the challenges of forecasting 50-years into the future – it remains clear that under its current trajectory, the nation’s finances will be put under increasing, nay insurmountable, pressure.

Yesterday, afternoon the ECB met market expectations in cutting rates by 25bps. This marks the central bank’s second cut in two months, following nine consecutive months of rates being held at their highest level in history.

The 25bps cut brings the ECB’s deposit rate facility to 3.5%, while their marginal lending facility and main refinancing operations rate will ease to 3.9% and 3.65%, respectively, on 18 September 2024.

The decision to cut follows a further easing of headline inflation and concerns around growth.

While the ECB loosened monetary policy further, they cautioned that “the Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner” and as such “will keep policy rates sufficiently restrictive for as long as necessary”.

With German wage negotiations in full swing, Frankfurt remain cautious about the extent to which the labour market could feed into inflationary pressures.

Looking ahead, the ECB forecast headline inflation (annualised CPI) to average 2.5% over 2024, 2.2% during 2025, and 1.9% in 2026. In the nearer term, policy makers warned that inflation could rise from its current 2.2% level given that previous sharp falls in energy prices will drop out of the annual rates.

The ECB also upwardly revised their core inflation expectations for this year and next, citing higher than forecast services inflation.

Regarding the ECB’s balance sheet, the central bank outlined that they would continue with quantitative tightening, reducing the PEPP portfolio by €7.5 billion per month on average. This follows their guidance on 6 June that they will reduce their balance sheet passively by this figure each month through not reinvesting maturing securities.