Spring Statement: Chancellor opens his wallet – but not much

Nine billion may look like a big number, but sometimes looks are deceiving. The £9bn in extra support announced by the Chancellor this afternoon will go only a little way to easing the burden on households over the rest of this year. That’s because we’re still expecting inflation to peak at more than 8%, and to be above 6% at the end of the year.

This will lead to the biggest cost-of-living squeeze on record, despite a tight labour market and flat GDP in the second half of the year. That’s a major reason why it would have been better for the economy if the Chancellor had used more of the headroom he has against his fiscal mandate, rather than saving it for a pre-election giveaway.

Higher inflation and lower growth

The Office for Budget Responsibility (OBR) now estimates that inflation will peak at almost 9% in Q4 2022 as higher oil and gas prices feed through into higher inflation. This would leave inflation at an average of almost 7.5% for 2022 as a whole, the highest level of inflation since the 1970s.

However, the OBR expects inflation to fall sharply from Q2 2023, even for it to fall below the Bank of England’s 2.0% target by the end of 2023 as it assumes energy prices drop. This is theoretically possible should energy prices fall back sharply, but it’s a factor that’s too dependent on the geopolitical situation to give a sensible forecast for.

This surge in inflation will lead to a drop of a little over 2% this financial year – which is the largest decline in real household disposable incomes on record. This means the OBR expects GDP growth of 3.8% in 2022, not far off our own estimate of a 3.5% rise.

Stronger recovery means a tax windfall

As expected, a stronger economic recovery from the pandemic meant the Chancellor gained a windfall as the OBR revised down borrowing in 2021/22 by a whopping £55bn. But the OBR revised up borrowing in 2022/23 by about £16bn. This move partly reflects the surge in interest rate costs, which doubled compared to the October forecast to £83bn, a record high. It also partly reflects the £17.6bn of support for household incomes in 2022/23, which consists of:

  • £8.9bn in support for households’ energy bills (£6bn of which is recouped over the subsequent five years);
  • £2.4bn via a one-year 5p cut in fuel duty; and
  • £6.3bn via raising the primary NICs threshold, from £9,880 to £12,570.

Overall, the changes to the OBR’s economic forecast mean the Chancellor had about £20bn of fiscal headroom against his targets. He has used about £10bn of that to raise the national insurance threshold and cut income tax, but this still leaves him about £10bn against his fiscal target for additional tax cuts or spending.

What does it mean for the economy?

At the margin, the additional support announced today will boost economic growth in 2022-23 by about 0.3 percentage points. However, the total amount of support announced so far this year will only offset about a third of the increases in costs faced by households.

Indeed, the huge rise in prices will mean there is likely to be very little growth in GDP in the second half of the year. The one silver lining is that households have accumulated close to £250bn of excess savings. To put that into context, UK households spent about £32.4bn on electricity and gas in 2020, so a 50% rise would see them spending an extra £16bn. If households dip into their savings to counter rising prices, or the government acts to support households, then the impact on GDP growth may be smaller than we have assumed.

Admittedly, the Chancellor also loosened policy in future years, partly by cutting the basic rate of income tax by 1p from 2024/25. By then, however, inflation will have returned to target and the economy won’t need fiscal support.