Chancellor Philip Hammond is facing a public finances black hole in next month’s Budget after the economic watchdog warned it would have to “significantly” slash its productivity growth forecasts.
The Office for Budget Responsibility (OBR) – whose forecasts form the basis of the Chancellor’s Budget decisions – has admitted it is set to cut its productivity predictions for the next five years in November’s forecasts, likely leading to lower growth and tax receipts.
In its Forecast Evaluation Report, the OBR said the productivity downgrade is expected to weaken the public finances outlook – which is likely to decimate the £26 billion headroom Mr Hammond had put faith in to ease the economy through Brexit.
It sets the scene for a difficult clutch of economic forecasts for Mr Hammond in his upcoming November 22 Budget.
The OBR warned: “We anticipate significantly reducing our assumption for potential productivity growth over the next five years.”
It added: “It is highly likely that the downward revision to productivity growth will dominate in terms of its effect on cumulative GDP (gross domestic product) growth over the forecast horizon and the associated consequences for the budget deficit.”
While better-than-expected borrowing since its March 2016 forecasts and ongoing falls in unemployment would help strengthen the Government’s books, the OBR said “the downward revision to productivity growth is likely to have the largest quantitative impact”.
Productivity refers to the amount of work produced either per worker or per hour worked.
The OBR said low investment by firms and the impact of rock bottom interest rates was partly to blame for the anaemic productivity growth, with low borrowing costs allowing “zombie” firms to survive.
The OBR also said uncertainty created by Brexit may be behind the productivity woes.
The Treasury said it was working to fix the so-called productivity puzzle.
A spokesman said: “Productivity has been a long-standing challenge for the UK economy, which is why we are focused on boosting our performance to deliver higher living standards and build an economy that works for everyone.”
FER17: as productivity growth disappoints again we review our forecast assumptions and the rationale underpinning them. pic.twitter.com/gPLo7NxX1l— Office for Budget Responsibility (@OBR_UK) October 10, 2017
The OBR said productivity had consistently fallen short of its forecasts, averaging just 0.2% over the past five years against last March’s forecast for a rise to 1.8% in 2021.
This is far short of the 2.1% a year increase seen in the pre-financial crisis era.
But the OBR offered some cheer as it said Government borrowing had been lower than it predicted – £2.8 billion less than it forecast in March – thanks to bumper tax receipts after stronger company profits and higher employment.
The OBR has confirmed that productivity estimates must be lowered. This is a damning indictment of the last 7 years of Tory economic failure pic.twitter.com/pG7gokMDUH— John McDonnell MP (@johnmcdonnellMP) October 10, 2017
The Office for National Statistics (ONS) also recently made a host of downward revisions to last year’s budget deficit, which the OBR said would be “beneficial”.
John McDonnell, Labour’s shadow chancellor, said Mr Hammond needed to deliver “substantial action” in next month’s Budget to address paltry productivity.
He said: “This OBR report supports Labour’s argument that weak investment is at the centre of our economy’s problems and has damaged productivity growth.”