2020 Budget: An economist’s view

It’s all hands to the pump as today’s Budget was accompanied by emergency measures from the Bank of England to meet the challenge posed by the coronavirus.

First, the Budget saw extra spending amounting to over 1% of GDP, with most of the support focused on smaller businesses with some help for employees and the self-employed. But this was not at the expense of the Government’s ambitions on long term investment, where Rishi Sunak promised £175 billion of spending over the next 5 years (over 1.5% of GDP a year). Despite the extra spending, Sunak expects public sector net debt to GDP to fall over the current Parliament despite lower expected growth.

But perhaps the biggest surprise came from the Bank of England. As well as an emergency cut in Bank Rate to 0.25%, the Bank announced it is restarting the Term Funding Scheme with a greater emphasis on supporting bank lending to SMEs (coined TFSME). Under this scheme banks will be able to borrow for a term of 4 years at Bank Rate, with an additional fee for any lender that fails to expand its lending during 2020. Additional funding is available for banks that increase their lending, particularly to SMEs.

The Office of Budget Responsibility (OBR) published its first economic forecast since March 2019 alongside the Budget. Even before the coronavirus became a concern the UK’s growth rate was slowing and Government deficit rising, so it is no surprise that the updated forecast has lower expected growth for this year and a higher public sector net deficit. The most striking feature of the OBR is the projected rise in the net borrowing not only this year but over the entire forecast period, with net borrowing expected to be £97 billion higher between 2020-21 and 2023-24, reflecting a choice by Government to push spending up.

In combination, the measures announced today have the potential to shore up confidence and alleviate some of the expected pressures on firms as the COVID-19 infection intensifies. But it is too early to know how seriously the UK economy will be hit by the virus so further fiscal and monetary measures may still be forthcoming over the next few months as the picture becomes clearer.

What we can say now is that global financial markets see the infection as more deflationary (pushing inflation down due to lower demand, as witnessed by the sharp fall in oil prices) than inflationary (disruption to supply chains causing shortages that could push some prices up). This can be seen in equities markets as the sell-off implies that investors believe that future profits will be lower and most spectacularly in the bond market, where Government bond yields have plummeted across the globe despite the prospect of Governments having to spend heavily to support the economy through a potentially severe period of disruption.

The bond market rally illustrates investors’ desire to shift into safe assets. But it is also the clearest signal that the markets see the impact of corona as deflationary, with investors now believing that inflation and short-term policy rates, such as UK Bank Rate, will stay lower for longer than previously expected.