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UK to borrow more as growth takes Brexit hit

Economy set to grow by 1.4% next year, down from the previous forecast of 2.2%. Investors welcome proposals to boost UK productivity.

UK to borrow more as growth takes Brexit hit

Chancellor Philip Hammond has announced a sharp downgrade in UK growth forecasts as a result of Brexit.

The economy is set to grow by 1.4% next year, down from the previous forecast of 2.2% made in the Spring Budget.

Delivering the Office of Budget Responsibility’s expectations for the path of growth as the UK begins to extricate from the European Union, Hammond further downgraded growth in 2018 from 2.1% to 1.7% and said it would steady at 2.1% in 2019 and 2020.

That still puts the official forecast for 12-month growth ahead of the City consensus of 0.9%, however. Over the period to the end of 2021 growth is expected to be 2.4% lower than previously forecast due to Brexit.

'The OBR's forecast for the public finances shows a deterioration since Budget 2016, due to disappointing tax revenues over the first half of this year, a weaker economic outlook weighing on receipts from income taxes, and higher spending by local authorites, public corporations and on welfare benefis,' said the Treasury.

As a result the government will have to borrow £32 billion more in 2020-21 than the OBR forecast in March, with debt peaking at over 90% of GDP in the next financial year.

This is why the chancellor has had to abandon his predecessor's aim to achieve a budget surplus by the end of this parliament.

'The government will return the public finances to balance as soon as possible in the next parliament,' the chancellor said.

Investor reaction

The FTSE 100, the pound and gilts all reacted negatively to the downgrades in Hammond's first Autumn Statement announcement. The FTSE 100 fell into the red, reversing gains the index had previously enjoyed ahead of the speech, dropping 27 points, or 0.4%, to 6,793. By the end of the day it had recovered some of these losses, trading at 6,818 points.

Gilt yields rose as prices fell on the back of concerns that lenders will be asked to provide an additional £15 billion in this fiscal year alone. During the day, 10-year gilt yields rose by over 8 basis points (0.086%) to 1.449%. This is slightly above levels before the Brexit vote. Since the end of August, bond yields have continued to rise due to concerns about inflation post-Brexit and the impact of incoming US president Donald Trump's policies.

Richard Carter, a fixed interest specialist at Quilter Cheviot, suggests that the OBR's forecasts could prove to be too negative.

'Of course, if there is one thing that you can rely on, it is that economists’ forecasts are seldom right in the long-run, so this may turn out to be an overly pessimistic outlook from the OBR.  So far, the UK economy has confounded the sceptics and proved to be remarkably resilient despite the Brexit uncertainty – perhaps this will continue,' he explained.

Hammond aims to tackle the long-standing problem of low UK productivity and placed it at the heart of his first Autumn Statement. He hopes to improve productivity by investing in infrastructure, whilst introducing initiatives that encourage innovation. Carter welcomes these policies describing them as 'very necessary'.

Toby Nangle, head of multi-asset at Columbia Threadneedle, also views the focus on productivity and infrastructure as a positive.

'Uncertainties surrounding Brexit are substantial, and surveys of business’ investment intentions have pulled back substantially over recent months. In this environment, the chancellor’s emphasis on investment in infrastructure and productivity is welcome,' he said.

As the UK has suffered poor productivity growth for a number of years, Nangle expects that increasing borrowing to invest in productivity-enhancing areas has the potential to boost GDP, especially given that the government can access cheap funding for the initiatives.

Others highlight the positive impact that the infrastructure spending plans could have on sentiment amongst UK companies. Paras Anand, head of European equities at Fidelity International, believes that the government's plans to increase spending could encourage companies to take their lead and invest more in their businesses. 

A lack of visibility due to the Brexit vote, coupled with concerns about economic growth has caused companies to rein in spending by retaining earnings within the business or distributing them to shareholders.

'It is the lack of certainty in the demand outlook that has driven companies to drive returns to shareholders through scale and efficiency,' he said.

'The truly positive case for the UK economy is one where this change in economic strategy does, in time, lead to a shift in the perception of risk that has constrained the corporate sector over recent years and we see the direction of private sector investment following that of the public sector.'

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