Very relevant for the "disruptors to growth" lesson - UK/financial rules

 

Rachel Reeves warned of risk to fiscal rules amid growth downgrade

OECD cuts forecast for UK growth for this year and next on rising trade uncertainty, high interest rates, and falling confidence

Mehreen Khan

, Economics Editor

Tuesday June 03 2025, 8.00am, The Times

Economics

Rachel Reeves

Spring statement 2025

Rachel Reeves, pictured with the prime minister Sir Keir Starmer, has been warned by the OECD that there is “a significant downside risk to the outlook if the fiscal rules are to be met”

REUTERS

Rachel Reeves has been warned she is at risk of breaching her fiscal rules if the UK economy is hit by a growth shock by the Organisation for Economic Cooperation and Development.

The Paris-based OECD has become the second major forecaster in two weeks to tell the chancellor that her “thin” fiscal buffers mean she could breach her deficit reduction target after the International Monetary Fund did so last week.

In its annual outlook on developed world economies, the OECD downgraded the UK’s growth outlook for this year and next on the back of rising trade uncertainty, high interest rates, and falling household and business confidence. The economy would expand by 1.3 per cent this year, down from an earlier estimate of 1.4 per cent and slow to 1 per cent next year, lower than an earlier projection of 1.2 per cent, the OECD said.

• OECD warns Reeves over risk to fiscal rules – follow live

Slowing growth means the UK’s public finances “are a significant downside risk to the outlook if the fiscal rules are to be met”, the OECD said.

“Currently very thin fiscal buffers could be insufficient to provide adequate support without breaching the fiscal rules in the event of renewed adverse shocks.”

Reeves left herself just under £10 billion in breathing room to meet her fiscal rules in the spring — one of the narrowest buffers on record. The chancellor’s main fiscal rule is to balance day-to-day spending with tax revenues by the end of the parliament.

The OECD’s intervention comes ahead of next week’s spending review, where Reeves is under pressure to manage ministerial budgets over the next three years after a recent U-turn on limiting winter fuel payments to pensioners.

The OECD advised the chancellor to strengthen the public finances with a “balanced” spending review and autumn budget which “combines targeted spending cuts, including closing tax loopholes; revenue-raising measures such as re-evaluating council tax bands based on updated property values; and the removal of distortions in the tax system”.

According to its projections, the UK’s budget deficit is on course to shrink from 6 per cent in 2024 to 4.5 per cent next year on the back of higher tax receipts. But higher market borrowing costs and interest rates mean the debt pile will expand to 104 per cent of GDP in 2026.

“Further supply-side reforms, including the overhaul of the National Planning Policy Framework, are expected to increase potential output and could help to lower fiscal pressures in the longer run,” the OECD said.

The Bank of England is expected to slowly loosen monetary policy with three interest rate cuts over the next 12 months, the forecast said.

In its first projections since President Trump launched his tariff policy, the OECD said global growth would expand by 2.9 per cent this year, compared to a March forecast of 3.3 per cent. The US received one of the biggest downgrades, with the economy expected to slow to a pace of 1.6 per cent this year after a 2.8 per cent expansion in 2024. Consumer price inflation will also climb to an average of 3.2 per cent from 2.5 per cent last year.

“Weakened economic prospects will be felt around the world, with almost no exception. Lower growth and less trade will hit incomes and slow job growth,” Alvaro Pereira, chief economist of the OECD said.

Oh gosh - Paradox of Thrift:

 

Britain’s recovery is threatened by the growing savings glut

Saving for a rainy day may seem prudent but can do an awful lot of damage when embraced by all at once

JEREMY WARNER24 February 2021 • 11:00am

Coiled spring or permanently rusted up old engine? Britain’s – and Europe’s – hopes for economic recovery are threatened by a toxic mix of poor productivity and high rates of saving. Inability to spend as freely as we would have liked for the past year, together with high levels of uncertainty about the future trajectory of the economy, has left both household and corporate balance sheets overflowing with excess deposits.

Persuading companies and consumers to disgorge at least some of these monies is key to the rapid bounce back in the economy anticipated by the likes of Andy Haldane, the Bank of England’s chief economist. His depiction of the UK economy as a “coiled spring”, just waiting to be released, doesn’t work if this excess has become permanently and uselessly frozen in bank and savings accounts. Haldane’s hopes rely crucially on a wall of pent-up demand progressively breaking free as Covid restrictions are lifted.Advertisement : 8 sec

The Bank of England estimates that with the savings rate as high as 26.5pc of disposable income at one stage last year, households accumulated an excess stock of savings of around £125bn between March and November, a number which is bound to have risen further still since then with the imposition of a third national lockdown.

The same level of accumulation has been broadly mirrored in the corporate sector, the Bank estimates. That’s a lot of money that could potentially flow back into demand once everyone is confident enough in the success of the vaccine programme to start acting normally again. 

Only one problem; these savings are not evenly distributed. Among households they are disproportionately skewed to higher income earners and retirees.

Much the same can be said of the corporate sector; companies that have survived the pandemic well will be flush with cash, but others, particularly in hospitality and other sectors forcibly closed by lockdown, will have barely two pennies to rub together.

The upshot is that those most likely to have saved the most are also those least likely to spend or invest it productively. Survey evidence seems to support this observation. Most respondents say they plan to keep at least some part of their excess. A permanently higher savings rate may have established itself.

If that turns out to be true, it feeds into the wider debate about growing wealth inequality and secular stagnation.

The economy at large is going to be in some trouble if the better off cannot be persuaded to spend their money, or otherwise invest it in productive activity, but instead simply leave it fallow in seemingly ever-rising asset prices. Poor levels of business investment, innovation and productivity growth would become embedded. And the bubble in asset prices would expand even further.

Instinctively, most of us are against negative interest rates, but you can see the logic. It is very difficult in practice to charge a negative rate on retail deposits; physical cash provides some kind of alternative. But for big, corporate depositors, that’s not an option.

Experience in Denmark, whose central bank was the first to impose a negative bank rate, suggests the threat of confiscation can be persuasive in forcing companies to invest their cash rather than hoard it. That debate has yet to play out within the Bank of England’s Monetary Policy Committee, but at least three of its members seem partially to have bought the arguments in favour of negative rates.

As David Owen of the investment bank Jefferies has argued it may be more important to get the corporate sector spending its surplus than householders. The estimated excess of £125bn is only 10pc of annual household spending, but around 50pc of business investment. Ergo, you get a much bigger relative effect if corporates disgorge the money than households.

That said, fiscal levers are always going to be preferable to monetary manipulation in spurring the hoped-for handover from public to private sources of demand. Negative rates are not going to persuade people and companies to spend and invest what they don’t already have but targeted tax cuts or even Biden-style handouts just might.

It is also possible to envisage any number of “use it or lose it” measures that could be applied to corporate cash hoarders. That’s why it is so important that Chancellor Rishi Sunak does not make the mistake of reining in the public finances too soon in next week’s Budget with much-rumoured “down payments” on fiscal consolidation, such as a hike in corporation tax. Not until households and firms are spending freely again can he afford to apply the brakes.

Keynes called it the “paradox of thrift”. What may seem a worthy, even admirable, characteristic on an individual level – that of saving for a rainy day – can do an awful lot of damage when households, companies and the state all decide to do it en masse.

A look at what is happening behind UK data

Is the UK's recovery really lagging other countries?

Economists urge caution on growth figures ahead of a tough fourth quarter

ByTom Rees12 November 2020 • 3:49pm

It’s rare that a record economic expansion can be described as a “disappointment” but Covid-19 has sent GDP figures careering literally off the charts.

Third-quarter growth figures pointed to an unmatched 15.5pc surge in GDP compared to the previous three months, rebounding from the record collapse during lockdown.

However, the slightly weaker-than-expected rise meant that output is still 9.7pc lower compared to the end of 2019, suggesting that the UK’s recovery is lagging well behind the US and eurozone economies. 

The Office for National Statistics (ONS) says that the gap between third quarter GDP and 2019 levels is twice as large as the shortfall in Italy, Germany and France, and almost three times the 3.5pc drop in the US. That may not tell the full story, however.

Some City economists warned the UK economy was losing momentum rapidly before the second lockdown. But others said the gloomy prognosis was derived from a statistical oddity. So what is really going on under the bonnet of the UK economy?

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The headline growth figures largely showed what economists already knew: the UK came out of recession in the third quarter but the recovery’s momentum is waning fast. 

Growth of just 1.1pc in September compared to the previous month came even before tougher restrictions in October and a national lockdown in England this month.

GDP in the fourth quarter is widely expected to slip back again.

The three main parts of the economy are still well behind on 2019 levels

Line chart with 3 lines.

The chart has 1 X axis displaying categories. 

The chart has 1 Y axis displaying Q4 2019 = 100. Range: 60 to 110.

The three main parts of the economy are still well behind on 2019 levels

Q4 2019 = 100

End of interactive chart.

Allan Monks, JPMorgan economist, says the “disappointment in September was fairly broad based”, leaving the economy’s momentum “a little weaker” than hoped. 

“Services sectors such as finance, IT and communication and administration and support showed little if any improvement over the month,” he explains.

Victoria Clarke, Investec economist, notes the UK’s collapse and recovery most closely matches struggler Spain. Both countries are more reliant on social consumption – face-to-face activities in the services sector, such as hairdressers and bars – and have failed to control their Covid outbreaks.

“The dominance of private consumption as a component of GDP in the UK appears to be one key factor here, with consumption still impeded, even after the re-opening witnessed so far,” she argues.

However, the ONS itself put a big disclaimer on country-by-country comparisons. Its statisticians warn that UK GDP is held back by the economy’s structure and new restrictions but also the timing of lockdowns and how different countries measure output.

Kallum Pickering, UK economist at Berenberg, advises: “Do not trust the headline data.” He argues nominal GDP may provide forecasters a “better guide” to the economy’s performance.

Real GDP measures output after adjusting for the impact of inflation, and it shows the UK lagging behind international peers.

However, nominal GDP records the country’s “cash” output before adjusting for price moves, and it tells a different story: by this yardstick, the UK’s recovery is largely in line with that of the US, Germany and France.

Pickering says “statistical factors that may be partly specific to the UK” appear to be playing a “significant role” in the headline figures. 

As the ONS says, international comparisons should “be made with care”. This is because the ONS’s way of measuring output from health and education – two sectors with output still well below pre-virus level – is different to other countries and could be a factor in exaggerating the decline.

“Unlike most other countries, real government expenditure is derived from the usage of public services,” explains Samuel Tombs, economist at Pantheon Macro. “As a result, this large shortfall reflects hospitals treating fewer patients than usual and schools staying shut until September.”

However, he argues that this distortion is not behind the UK’s weakness and instead highlights a lack of recovery in household consumption compared to other countries.

Economic figures are also prone to big revisions once better data is available. David Cameron’s government was pilloried for the UK suffering an infamous double dip recession in 2012. However, statisticians later rewrote history by revising their figures to show the economy escaped another recession after the financial crisis. 

Given the scale of the collapse and rebound in output in 2020, revisions could be larger than normal. Statisticians may have had more difficulties gathering data during the pandemic.

The ONS’s GDP figures are calculated using surveys, such as data from businesses, and “administrative sources” such as VAT receipts.

“We should be humble in the face of our limitations in our ability to actually measure this stuff,” says Pickering.

“The shock was so huge and we're talking about estimated statistics, which are based on samples of a normally functioning economy.

“All of the data will be prone to revision in the future so I would not be splitting hairs between a two percentage point difference between the UK and France in the second quarter.”

Perhaps more important is the future path of the economy. Forecasters now expect the economy to contract again in the fourth quarter despite the vaccine breakthrough boosting next year’s growth prospects.

Even if the UK’s recovery was stronger than the initial figures suggest, the return of lockdown means many of the gains will be lost again anyway