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The UK economy will end the year on a high, with the latest forecast from the Office for Budget Responsibility (OBR) expected to upgrade GDP growth, lower projections of public sector job cuts and reveal an overshoot in tax revenues, according to a report released yesterday by the Ernst & Young ITEM Club.

The ITEM Club special report – which has been released ahead of the autumn forecast from the OBR – says that the OBR is likely to increase its GDP estimate from 1.2% to nearer 1.7% for this year, bringing it into line with ITEM’s own projections.

Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club explains: “Since the OBR’s forecast in June, we’ve seen an impressive recovery in the economy and a particularly impressive recovery in tax revenues, which will undoubtedly be reflected in a more optimistic outlook in the OBR’s forecast.”

CSR balancing act saved 90,000 public sector jobs
ITEM Club also believes that, in what will be the OBR’s first opportunity to assess the impact of the Comprehensive Spending Review (CSR), the forecaster should be in a position to deliver some good news to the Coalition. ITEM predicts that the OBR could revise its estimates of public sector job losses down from 490,000 to around 400,000 – saving 90,000 jobs that would otherwise have been lost.

The CSR revealed a shift in the composition of the spending cuts that were originally set out in the Emergency Budget and factored in to the OBR’s June forecast. The Chancellor announced in the CSR that additional welfare reforms would enable him to bolster departmental budgets by an extra £11bn by 2014/15. ITEM says that the balance of these cuts should see the OBR revise down its estimate of public sector job losses.

Spencer explains: “Buffering departmental budgets with an additional 3% of current spending will have saved some public sector jobs, assuming that there will be a similar balance between staffing and procurement costs, and a similar rate of public sector wage growth.”

However, Spencer cautions that this balancing act will not be without its consequences. The additional savings made to welfare reform will feed through to reduced household incomes. As such, ITEM also expects the OBR to reduce its forecast for consumer spending growth throughout the forecast period.

Public finances remain on track
According to the report, UK tax revenues are also on track to overshoot the OBR’s original forecast by over £10bn this year. This has also meant that Public Sector Net Borrowing (PSNBX) is currently running well below 2009/10 levels.

Spencer comments: “The robust recovery in the corporate sector is starting to filter through to the Treasury’s coffers, with corporate tax revenues up 30% on the same time last year. Combined with a stronger than expected recovery in VAT and income tax revenues, UK tax receipts are looking much healthier.”

ITEM suggests that there is further potential for the public finances to improve more rapidly. Spencer says that the official projections for tax receipts are often beaten in a recovery.  And that on the spending side significant savings could be made on debt servicing costs once inflation begins to fall back, due to lower than anticipated short and long term interest rates by the market. 

But major uncertainties remain
But uncertainties abound for the UK around spending on welfare programmes and the achievability of the departmental cuts, which means that any revenue overshoots may not  feed through to the bottom line for the UK economy.

Spencer concludes: “Normally we would expect revenue overshoots to feed through to the bottom line for borrowing, but significant uncertainties in the economy will mean that the OBR’s longer term forecasts are likely to err on the side of caution. The achievability of the departmental spending cuts and progress on welfare reform remain major question marks for the fiscal outlook.”

Download the ITEM Club's special OBR preview report  387K, November 2010