Certain uncertainty. The Chancellor faces an especially challenging background to his Budget

With the EU Council meeting last week a relative success and all efforts on the Brexit front now focused on reaching an interim agreement at the next such encounter in December, the largest single political event facing the Government now is the Budget scheduled for 22 November. This is a particularly significant and challenging occasion for Philip Hammond personally.
This is, firstly, because this will be an out-and-out Budget and not the Autumn Statement of previous years and is thus expected to be the most important financial moment of the calendar year. Second, there has been a campaign of sniping against Mr Hammond of late, largely led by those who feel that neither he nor the Treasury is demonstrating the required confidence in the UK’s future outside of the EU. While it would be an exaggeration to suggest that his position is on the line, he could do with increasing his standing with certain colleagues. Finally, this is a Budget that is to be delivered against an especially challenging background where uncertainty of various forms appears to be the one certainty that the Chancellor, his officials, and the Office of Budget Responsibility can be sure of.
The degree of uncertainty – economic, parliamentary and policy – is such that Mr Hammond is due a shot of sympathy. This is an exceptionally hard Budget to deliver because even the most basic of UK economic assumptions are suspect. The Bank of England will find itself in a similarly unclear place a few weeks later when it decides whether or not to see through its hints issued earlier this month that it would increase interest rates for the first time in a decade. The choice facing Mark Carney and his colleagues is, though, at least binary. They can, realistically, either keep rates at 0.25% or raise to 0.5%. They could also duck a decision but make it plain that they will be decisive later. This is not an option open to the Chancellor. Yet, as set out below, he is in stuck in close to crystal ball territory.
Economic uncertainty
The economy is currently operating in a somewhat confusing manner. As the preliminary estimate of growth in the third quarter of this year issued this morning appears to confirm, it is expanding at a slower rate than last year and at below what is believed to be its long-term trend level (which varies between 2% and 2.5% according to different schools of thought). Most of the projections which were made at the outset of 2017 look set to be optimistic.
Yet despite a relative slowdown, the employment rate (at 75.1% of adults aged 16-64) is very high and unemployment rate (4.3%) is very low. Increased numbers in the workforce has assisted tax revenues which has meant that the level of government borrowing is continuing to decrease and is likely to undershoot its target. Although inflation is high by recent standards (3%), it appears to be close to the peak that was prompted by the devaluation of sterling after the EU referendum result last summer. Even so, prices are high enough to outpace real wage growth (at only 2.2%) which means that real wages in the UK today are the same as those of February 2006 and hence have still not recovered from the financial crisis even though almost a decade has passed since Lehman Brothers went under. More starkly still, real wages in the UK have taken the hardest hit of any OECD member country bar that of Greece.
This is a very complex picture to assess. It is incredibly hard to call whether the UK economy is in a temporary stall triggered by more cautious and less prosperous consumers combined with a lack of capital investment while so much to do with Brexit is seemingly up in the air, or whether we are due a number of years of similar slow growth, or whether a full-blown recession is around the corner. Hence, the Chancellor cannot really assess whether he should be stimulating the economy, even at the price of slower deficit reduction, or whether this should be a steady-as-she-goes Budget instead. He is not likely to receive much in the means of assistance from the OBR which does not offer the impression of having any more of a clue as to the direction of travel for the economy than anyone else. Ironically, Mr Hammond may have made an already awkward situation worse for himself by his (otherwise entirely rational) decision to downgrade what would have been another chance next March to think again based on more data in what would otherwise have been his Spring Budget.
Parliamentary uncertainty
This economic conundrum is not helped by the numbers in the House of Commons. Even if the most Eurosceptic elements in the Conservative Party were not aggrieved with him, Mr Hammond would be in a tricky parliamentary situation.
The terms of the agreement between the Conservatives and the Democratic Unionist Party reached after the June election means that the Chancellor knows he has the numbers to ensure that the final vote on the Finance Bill is carried. This is not the same as being confident that he will have the numbers to support any specific item that he might announce in his Budget speech.
He could be vulnerable either to the DUP refusing to back an individual policy or a small number of Conservative MPs indicating that they would be willing to align with the Labour Party on any proposal which they did not care for. Even when his party had an (albeit slim) majority in the House of Commons earlier this year, Mr Hammond found himself obliged to abandon what had been one of the main planks of his Budget, national insurance rates and the self-employed. He will not want to endure a similar indignity again, but in parliamentary terms is even more vulnerable.
This matters because in ordinary circumstances, the first Budget of a new Parliament is normally the hour at which a Chancellor disposes of some bad news and hits those who would normally consider themselves to be his allies (Exhibit A in this regard, George Osborne, carried interest, July 2015). The political logic here is that by doing the damage at this stage, the pain has been forgotten by the time that the next election eventually arrives, or has been replaced by fear that the other lot may be even worse for the individuals or industry concerned.
With the numbers in the House of Commons today, Mr Hammond has to be extremely careful as to whom he offends. Any assault on what might be seen as a natural Conservative constituency would be a risky endeavour. He needs to minimise the amount of unnecessary unpopularity that he brings upon himself and the rest of the government. So while he has signalled a willingness to be ‘radical’, even ‘revolutionary’, in his ambition to address the thorny question of intergenerational economic fairness, he may have to be cautious in practice.
Policy uncertainty
The final element in all this uncertainty is Brexit. If the original timetable for the EU deciding that ‘sufficient progress’ in Brexit negotiations had been met, then the Chancellor could frame his measures with a reasonable degree of confidence that there would definitely be a deal allowing for an orderly exit and that a transition period was all but inevitable too. This remains the most plausible course of events but it is not absolutely certain. He therefore has to decide on a Budget next month without knowing all that he would like to know about the status of Brexit for 2018-2019.
To take one example with a huge impact for the private equity and venture capital sector, Mr Hammond has to make a decision on the resources that he allocates to the British Business Bank without being able to estimate with any confidence whether the amount that will be invested in the UK by the European Investment Fund next year will be close to zero or a return to the record levels witnessed in 2016 or somewhere between these extremes (which are a wide range). There are several similar dilemmas in the system. Every Budget involves an element of hope and faith. On 22 November, hope and faith will be the main features of the forecasts and measures.
Tim Hames
Director General, BVCA