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The Guardian - UK
The Guardian - UK
Business
Graeme Wearden

Britain warned to expect 'nasty fiscal surprises' after failing stress test – as it happened

The London financial district
The London financial district Photograph: Tim Robberts/Getty Images

Our economics editor, Larry Elliott, says today’s OBR report shows the shortcomings in government policy since 2010:

He writes:

It was one of George Osborne’s most effective soundbites. Before, during and after the 2010 general election, the man who served as David Cameron’s chancellor for six years blamed his austerity measures on Labour’s failure to “fix the roof while the sun was shining”.

What goes around comes around. The Office for Budget Responsibility was set up by Osborne in 2010 to keep tabs on the state of the public finances free from the clutches of politicians and has now published its first report into the long-term fiscal risks facing Britain.

Its message was brutally simple. The UK has had a recession once in every decade since the 1970s and there is a 50% chance of there being another one in the next five years. Recessions play havoc with the public finances: three of those since the 1970s have seen the budget deficit – the difference between what the government spends and its income in any one year – rise to 6% or more.....

Here’s Larry’s full analysis:

If you missed this morning’s report on the UK credit market, then catch up here:

Here’s our news story on the OBR’s fiscal warnings, for anyone just tuning in:

UK public finances face twin threat from Brexit and downturn, says OBR

Britain’s public finances are in worse shape to withstand a recession than they were on the eve of the financial crash a decade ago and face the twin threat of a fresh downturn and Brexit, the Treasury’s independent forecaster has warned.

The Office for Budget Responsibility – the UK’s fiscal watchdog – said another recession was inevitable at some point and that Theresa May’s failure to win a parliamentary majority in last month’s election had left the public finances more vulnerable to being blown off course than they were in 2007.

In its first in-depth analysis of the fiscal risks facing Britain, the OBR said its main message was clear: “Governments should expect nasty fiscal surprises from time to time – because policy can only reduce risks, not eliminate them – and plan accordingly.

“And they have to do so in the context of ongoing pressures that are likely to weigh on receipts and drive up spending and a variety of risks that governments choose to expose themselves to for policy reasons. This is true for any government, but this one also has to manage the uncertainties posed by Brexit, which could influence the likelihood or impact of other risks.”

The OBR said the size of the UK’s Brexit divorce bill – currently a matter of dispute between London and Brussels – would have little impact on the public finances. But it noted that even a small fall in Britain’s underlying growth rate after departure from the EU would lead to a big increase in the country’s debt burden.

“If GDP and receipts grew just 0.1 percentage points more slowly than projected over the next 50 years, but spending growth was unchanged, the debt-to-GDP would end up around 50 percentage points higher,” the OBR said.

The OBR noted that Brexit was not the only threat to the government’s aim of eliminating the UK’s budget deficit. It said a hung parliament and “austerity fatigue”, alongside longer-term developments such as a rapidly ageing population, were also factors putting upward pressure on the deficit...

More here:

In other news.... the number of Americans filing new claims for unemployment benefit has fallen, for the first time in a month.

The initial jobless claims fell to 247,000 last week, from 250,000. That suggests the US labo(u)r market is still pretty robust.

UK fails OBR's fiscal stress test

Britain’s economy has failed a fiscal ‘stress test’ created to see how it would cope with a new financial crisis.

The test, published in the OBR’s fiscal report today, models the impact of a deep recession, a tumbling stock market and a sterling crisis, which creates “lasting effects on potential output”.

And the bad news is that Britain would suffer ‘severe’ fiscal effects:

  • The deficit would rise to 8.1% of GDP by 2021-22 (of which 7.4% would be structural, and couldn’t simply be grown away)
  • The national debt would rise to 114% of GDP (compared to 85% today)
  • The deficit would be £66.2bn higher in 2017-18, rising to £158.5 billion higher by 2021-22

And to sum up:

The Government’s fiscal targets would be missed by wide margins.

This chart shows the full damage, and explains why the OBR fears Britain is in a vulnerable position when the next crisis strikes.

OBR stress tests

Labour’s shadow chancellor has also responded:

The chancellor, Philip Hammond, has described the OBR’s report as:

“a stark reminder of why we must deliver on our commitment to deal with our country’s debts”.

Snap analysis: OBR urges caution with the fragile public finances

The broad message from the Office for Budget Responsibility is that Britain’s public finances are in a troubling state, vulnerable to nasty surprises, and with a shedload of troubles looming on the horizons.

And Brexit could make this whole situation worse, as slower growth over the long term could drive the debt/GDP ratio into the danger zone, over 100%.

Today’s report reaches three main conclusions:

1) The government must keep “endogenous risks under review”. That means risks created or influenceable by government policy - everything from the pension triple-lock to the cost of cleaning up Britain’s nuclear power stations.

The problem, I suspect, is that there may not be many votes in dealing with certain risks....

2) Britain must prepare for shocks. There may not be a recession this year. Or in 2018. But there will be one eventually, so future budgets need to create some fiscal space to react. According to the OBR, Britain will suffer at least one financial crisis and several recessions over the next 50 years.

And even if the government avoids a classic economic downturn, the economy could be hurt by a natural disaster, a terror attack or a war.

3) Ministers must deal with many sources of slow-building pressure. Britain has a nasty habit of putting off difficult decisions or unpleasant problems (for example, social care for the elderly). But problems don’t go away if you ignore them. They just build up.

This chart shows how the ratio between retirees and workers will rise steadily over the next few decades. More old people will need support, and the pool of taxpayers won’t grow fast enough to keep pace.

OBR report

Updated

Political and financial journalists and commentators are trawling through today’s Fiscal Risks report, and tweeting the key points and hidden gems.

Here are some of the best so far:

Today’s Fiscal Risks report includes this chart, showing the key threats to Britain’s public finances:

OBR risks

The cost of supporting Britain’s ageing population is the biggest single pressure on public spending, says the OBR.

Today’s report states:

Pressures on public spending abound. By far the biggest relate to health, where an ageing population is raising demand while technological advances raise costs. Ageing also creates pressures on adult social care and the state pension – which each face policy-driven cost pressures in the form of the National Living Wage and the triple lock respectively.

But there are many other pressure too. The OBR suggests:

  • The uncertain costs of cleaning up nuclear power stations,
  • compensating victims of clinical negligence and reimbursing tax that the courts determine should not have been collected.
  • In the near term the Government may also need to finance an extensive programme of fire safety measures in the wake of the Grenfell Tower tragedy.

All these have to be considered in the context of medium-term spending plans that imply significant real terms cuts in spending per person over the next three years, on top of those implemented since 2010.

And on the increasingly unpopular 1% public sector pay cap... the OBR cautions that the money would have to come from somewhere....

Lifting current limits on public sector pay increases would pose a fiscal challenge to the extent that departments had their budgets increased to pay for it, rather than simply giving them greater flexibility over how they manage their pay bills.

OBR: Public finances are much more susceptible to shocks

The Office For Budget Responsibility is also critical of the state of the UK public finances.

The independent watchdog warns that Britain is “much more sensitive to interest rate and inflation surprises” than in the past -- hardly a ringing endorsement of the government’s handling of the economy.

It says:

We produce this report at a sensitive time. A decade after the outbreak of the financial crisis and recession, net borrowing is well down from its peak. But the budget is still in deficit by 2 to 3 per cent of GDP – as it was on the eve of the crisis – and net debt is more than double its pre-crisis share of GDP and not yet falling. As a result, the public finances are much more sensitive to interest rate and inflation surprises than they were.

The OBR also highlights the recent turmoil in Westminster:

In terms of the political backdrop, the previous Government had to abandon a number of measures to increase taxes and cut welfare spending, the new Government has just agreed a ‘confidence and supply’ arrangement that increases public spending significantly in Northern Ireland and the Chancellor of the Exchequer notes of austerity that “people are weary of the long slog”.

The OBR also identifies ‘austerity fatigue’ as a threat to the government’s control of the fiscal purse strings.

OBR: Brexit 'divorce bill' isn't the main threat to stability

The OBR makes a very important point about Brexit.

The long-term impact of leaving the EU will have a bigger impact on Britain’s long-term fiscal heath than the upfront cost of exiting the EU.

And a small hit to growth over the long term would drive Britain’s national debt dramatically higher.

In today’s report, the watchdog says:

The new Government must also manage the risks posed by Brexit. These do not supplant the possible shocks and likely pressures that we have already discussed, but they could affect the likelihood and impact of many of them.

A lot of attention focuses on the possible ‘divorce bill’, but, while some numbers mooted for it are very large, a one-off hit of this sort would not pose a big threat to fiscal sustainability. More important are the implications of whatever agreements are reached with the EU and other trading partners for the long-term growth of the UK economy, which we do not attempt to predict here.

If GDP and receipts grew just 0.1 percentage points more slowly than projected over the next 50 years, but spending growth was unchanged, the debt-to-GDP would end up around 50 percentage points higher.

Britain’s debt-to-GDP ratio is currently 85%, so you can see how significant slower growth would be over half a century....

The chance of a recession in any five-year period is around one in two, says the OBR.

And financial crises come along too often for comfort too.

The OBR says:

The chance of a financial crisis in any five-year period is around one in four, but thankfully not all are as big or as costly as the most recent one.

Updated

OBR: Government should expect "nasty fiscal surprises"

Breaking: The Office for Budget Responsibility, Britain’s fiscal watchdog, has just published its latest Fiscal Risk report.

It urges the UK government to prepare for ‘unexpected’ surprises (and not the nice sort, either), given its “vulnerable fiscal position and a challenging political environment”.

The report points out that Britain’s budget is still in deficit by 2 to 3 per cent of GDP – as it was on the eve of the crisis – and net debt is more than double its pre-crisis share of GDP and not yet falling.

The OBR says that Westminster should remember that recessions and financial crises are “almost inevitable over a 50-year horizon”, and plan accordingly.

The main message is clear: governments should expect nasty fiscal surprises from time to time – because policy can only reduce risks, not eliminate them – and plan accordingly. And they have to do so in the context of ongoing pressures that are likely to weigh on receipts and drive up spending and a variety of risks that governments choose to expose themselves to for policy reasons.

This is true for any government, but this one also has to manage the uncertainties posed by Brexit, which could influence the likelihood or impact of other risks.

And for that reason, the OBR says, the Treasury should be cautious of signing off unfunded spending commitments.

But new unfunded ‘giveaways’ would take the Government further away from its medium-term fiscal objective and would only add to the longer-term challenges.

In many recent fiscal events, giveaways today have been financed by the promise of takeaways tomorrow. The risk there, of course, is that tomorrow never comes.

More to follow....

Updated

AstraZeneca shares hit by CEO rumours

Chief Executive of AstraZeneca Pascal Soriot.

AstraZeneca is the biggest faller on the FTSE 100 index, with investors unnerved by a media report that chief executive Pascal Soriot has been offered a job by Israel’s Teva Pharmaceutical Industries.

AstraZeneca declined to comment, saying it never comments on market speculation. Its shares fell more than 5% in early trading and were later down 4.7% at £49.49.

Financial news website Calcalist said Soriot would earn twice as much as his predecessor at Teva and receive a signing-on bonus of about $20m, although the financial terms were still being discussed. Teva has been without a permanent CEO since February when Erez Vigodman stepped down, and its finance chief Eyal Desheh resigned at the end of last month.

Soriot has run Britain’s second-biggest drugmaker since 2012 and famously fought off a takeover approach from American rival Pfizer at £55 a share in 2014. He has focused on rebuilding the drug pipeline to replace lost revenues after a string of patent expiries on blockbuster medicines, by investing in areas such as immuno-oncology – drugs that harness the body’s immune system to fight cancer.

The Bank of England’s credit survey has also found that demand for buy-to-let loans has fallen.

That may show that recent tax changes, which make BTL less profitable, are hitting demand.

Other mortgage lending remained solid, though.

The BoE says:

Lenders reported that demand for secured lending for house purchase was unchanged in Q2 (Chart 3 below). Within this, demand for prime lending increased and demand for buy-to-let lending decreased significantly.

Lenders expected total demand for secured lending for house purchase to increase in Q3, driven by an increase in buy-to-let lending and a slight increase in prime lending. Demand for remortgaging was reported to have decreased slightly in Q2, but was expected to be unchanged in Q3.

Lending figures

Back in April, the government began cutting back at the interest relief enjoyed by BTL landlords.

Those changes will stop them deducting mortgage interest and other finance-related costs from their rental income before calculating their tax liability. Some landlords say their total tax bill will soar, making buy-to-let much less financially attractive....

Cambridge economics professor Victoria Bateman is concerned by the rise in credit card defaults:

Economist Rupert Seggins shows why we should take the Bank’s survey seriously:

Credit card defaults have risen

In an alarming development, more people are defaulting on their credit card bills and other unsecured loans.

The Bank of England’s survey of credit conditions has found that the default rates on both credit card and other unsecured lending to UK households have “increased significantly” in the second quarter of this year.

Worryingly, defaults are “expected to increase further on credit card lending” in the third quarter.

That’s a sign that UK households are struggling to meet their financial obligations, perhaps because inflation is now outstripping wage growth.

As this chart shows, there was a sharp jump in the number of lenders reporting that default rates have risen.

BoE: Credit supply is shrinking

Newsflash: The availability of credit in the UK economy is likely to fall this summer.

That’s according to the Bank of England’s latest credit conditions survey.

It suggests that banks and other lenders are becoming more cautious about making new loans, reflecting caution over Britain’s economic prospects.

The survey found that there will be less ‘secured credit’, such as a mortgage, on offer over the next quarter. This will particular affect people who only have a small deposit for their house.

The Bank of England says:

The availability of secured credit to households was reported to have increased in the three months to mid-June 2017 (Chart 1 below), driven by lenders’ market share objectives. But lenders expect availability to fall slightly over the next three months to mid-September, reflecting a changing appetite for risk. Lenders expect that slight reduction in availability to affect only borrowers with loan to value (LTV) ratios of more than 75%, and in particular those with a LTV ratio of more than 90%.

UK credit

Lenders also told the BoE that the availability of unsecured credit (such as credit cards) dropped in the last three months. It will probably continue to decline as lending criteria are tightened up....

Lenders reported that the availability of unsecured credit to households had decreased in Q2 (Chart 2), and expected a further decrease in Q3. A changing appetite for risk was reported to be an important driver of this in Q2 and Q3, with a changing economic outlook also affecting expectations for Q3.

Credit scoring criteria for granting both credit card and other unsecured loans were reported to have tightened again in Q2, with lenders expecting further tightening in Q3.

UK credit

Updated

Troubled construction group Carillion is having another bad day.

Shares have hit fresh record lows this morning, as the shock profit warning issued on Monday continues to alarm investors.

They fell as low as 51p, down another 10% today. That meant Carillion has lost almost three quarters (!) of its value this week, since shocking shareholders by taking a monster£845m provision against contract losses.

Analysts believe Carillion needs to raise £500m in fresh capital to avoid collapse - or more than double its current value.

My colleague Simon Goodley explains what went terribly badly wrong:

For many, the morning of 8 July promised a feast of sport: the British Lions Test in New Zealand, a Lord’s Test and Wimbledon. But a small group of bankers were about to have their weekend ruined by a summons to an emergency meeting in London’s Maddox Street.

Board papers had been delivered to the homes of the directors of Carillion, a FTSE 250 business best known as a builder that works on huge construction projects, and the documents contained disturbing news. A review of the group’s finances, commissioned two months earlier from accountants KPMG, had unearthed a gaping hole in the accounts.

Meetings through Saturday and Sunday produced an 800-word statement to the stock exchange, which shocked the City when it was released at 7am on Monday morning. It was a monster profit warning following an £845m writedown, of which £375m related to three large public private partnership (PPP) contracts in the UK and £470m to the cost of pulling out of several markets in the Middle East and Canada....

Over in the City, shares in home shopping group N Brown have slumped by 8% in early trading.

The company has just admitted that it sold flawed insurance products for many years, and faces a £40m bill to put it right.

The pound is also rallying against the euro, up 0.4% at €1.133.

That takes sterling away from the eight-month low of €1.119 struck yesterday.

The pound has jumped after Ian McCafferty’s comments about possibly unwinding QE early hit the wires.

Sterling has gained more than half a cent against the US dollar, to $1.295.

The pound vs the US dollar this week
The pound vs the US dollar this week Photograph: Thomson Reuters

That adds to yesterday’s gains, when the US dollar fell generally following Janet Yellen’s testimony.

Ian McCafferty: Need to think about unwinding QE

A Bank of England policymaker has spiced up the growing debate over UK monetary policy, by calling for an early end to its huge quantitative easing programme.

Ian McCafferty, who is one of the most hawkish members of the Monetary Policy Committee, argued that the BoE should rethink its current policy of not unwinding QE until interest rates have risen close to more normal levels.

Speaking to The Times, McCafferty point out that the Federal Reserve is already outlining plans to normalise its balance sheet:

Given that other central banks are thinking about it, I think it would be remiss of us not to at least think about it.

The Bank of England currently holds £435bn of debt (mostly government bonds), bought with newly created money during the financial crisis.

QE drove up asset prices, pushed down Britain’s borrowing costs, and (apparently) stimulated the economy. Unwinding the programme is going to be tricky, and could easily drive up the long-term cost of borrowing - crucially important to banks, mortgage-payers and governments alike.

The Bank of England has previously explained that QE wouldn’t be touched until interest rates had returned to 2% (they’re just 0.25% today).

McCafferty also dropped a loud hint that he is planning to vote for an interest rate hike in August - as he did in June.

He said:

As of today, I would not be changing my position.

This means that August’s crunch meeting is likely to see a big split at the Bank; Michael Saunders is also expected to vote to hike borrowing costs, and there’s speculation that chief economist Andy Haldane could join the hawks too.

McCafferty argued that the UK economy could handle higher interest rates, pointing out that the jobless rate has hit a 42-year low. He also warned that inflation is likely to “peak at over 3 percent” - well over the BoE’s 2% target.

The agenda: Digesting Yellen; waiting for UK credit figures

Good morning, and welcome to our rolling coverage of the world economy, the financial markets, the eurozone and business.

World stock markets are pushing higher today as investors digest yesterday’s testimony from Federal Reserve chair Janet Yellen to Congress.

Asian stock markets have hit a two-year high, following gains on Wall Street, after Yellen was more dovish than expected. The Fed chair signalled that US interest rates will continue to rise gradually, and singled out weak inflation as a key factor.

As Michael Hewson of CMC Markets explains:

Equity markets jumped sharply yesterday with the Dow hitting a new record high, while the US dollar slumped after Fed chief Janet Yellen caught investors by surprise by leaning back from the prospect of multiple rate hikes in the coming months.

Market reaction was also reinforced by her comments that inflation was running below target and that rates wouldn’t need to rise much further to get back to neutral. This comment in particular suggests that the Fed believes that a lot of the heavy lifting on rates may well have been done in the short term, which may help explain why we saw long term yields slip back down to a one week low, and certainly takes a September rate rise off the table.

European markets romped ahead during Yellen’s testimony, and are expected to hold onto those gains this morning

But the mood could change at 9.30am, when the latest UK consumer credit figures are released. They will show whether Britons have been hitting their credit cards, to cope with the fact wages aren’t keeping up with prices.

The data could also show whether lenders have been more cautious about extending credit.

RBC Capital Markets say:

Last time the survey indicated that lenders were anticipating tightening conditions on unsecured household lending so this edition will reveal whether or not that intention came to fruition.

We also get the latest US weekly jobs report, while Janet Yellen will head back to Capitol Hill for a second day of testimony.

Here’s the agenda:

  • 9.30am: Bank of England credit conditions survey
  • 1.30pm: US weekly initial jobless claims figures
  • 3pm: Janet Yellen testifies to the Senate banking committee

Updated

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