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Autumn Statement: answers to the most frequently-asked economic questions

As the dust settles on Wednesday’s Autumn Statement, Schroders addresses the key questions posed by investors.

24/11/2023
Photo of Houses of Parliament, London

Authors

Azad Zangana
Senior European Economist and Strategist

The Autumn Statement is meant to be a non-event in the UK’s fiscal calendar, but in recent years they have been used to announce a raft of policy changes. Wednesday’s Autumn Statement was one of the busiest, with a reported 110 growth initiates unveiled, along with significant tax cuts and spending increases.

As usual, questions from clients and others swiftly follow. Here are our answers.

How has the economic outlook changed?

The UK economy is forecast to grow by 0.6% this year, accelerating to 0.7% in 2024 and 1.4% in 2025, according to the Office for Budgetary Responsibility (OBR) published alongside the Autumn Statement on Wednesday. Real GDP growth then settles at 2% per annum in 2026 and 2027, before slowing to 1.7% in 2028 and the end of the forecast. Compared to the forecast from the Spring Budget in March, this year’s growth estimate has been revised up by 0.8 percentage points, but both 2024 and 2025 have been revised down by 1.1 percentage points, with smaller revisions to the outer years.

Charts showing UK growth and inflation forecasts

The inflation outlook has also worsened. While inflation has fallen back from the multi-decade highs at the end of last year, CPI inflation is forecast to average 7.5% in 2023 and 3.6% in 2024 – 1.3 and 2.8 percentage points higher than the previous forecast.

What is the Government proposing, and how can it afford it?

Although the growth outlook has been downgraded, it’s worth mentioning that the OBR appears relatively optimistic when compared to the Bank of England. The Bank has GDP growth at just 0.1% in 2024 and 0.2% in 2025.

Schroders’ forthcoming forecast will also be more pessimistic and includes a technical recession in the first half of 2024. If the OBR’s forecast proves to be too optimistic, then the Government’s “fiscal headroom” may not be as high as it thought.

Despite the risks around projections, the chancellor has decided to spend all of the £27 billion of fiscal headroom the OBR has identified. Note, this does not mean that the Government has saved £27 billion and it is now being spent. It means that the if the OBR is correct, then the Government will borrow £27 billion less than previously thought – which was already a high amount. Chart 3 below shows how annual borrowing would have fallen without the latest measures (“Pre-measures”) and with the measures announced.

Chart showing UK government's fiscal headroom

How does the Government plan to boost growth?

The focus of the Autumn Statement is to boost the supply side of the economy, and included a number of measures that aim to boost businesses investment. The biggest announcement was the extension of the 100% capital expenditure allowance, which allows companies to deduct expenditure on plants and machinery from taxable income.

The tax break was introduced in the last budget, and was supposed to come to an end in March 2026. This was introduced after the previous “super-deduction” (130% of spending) came to an end, but which had ran in the previous two years. It’s worth remembering that these support measures were introduced after the Government raised corporation tax rates, which were expected to reduce business investment and trend growth.

The ”full expensing” as it is now referred to will become permanent, although interestingly, the OBR estimates that the change could slow investment in the near term as the removal of a deadline reduces the need for businesses to bring forward investment plans. However, over the long term, the policy is expected to lift investment and growth.

In addition to businesses, the chancellor decided to also focus efforts on the labour market. One of the most disappointing developments through this economic cycle has been the lack of recovery in the employment rate. Many individuals have remained inactive, choosing not to return to work (or to seek work), with many citing long-term sickness or caring for others as the primary reason.

The government has accepted the recommendation of the Low Pay Commission to lift the National Living Wage by 9.8% (compared to 4.6% inflation at present) for 21 and 22 year-olds. The National Minimum Wage for young people and apprentices will rise by 14.8%, and by 21.2% for those aged 16-17. This is helpful for those individuals, but the lack of participation is not concentrated at those age groups, and unlikely to be for those income groups.

However, the second major announcement may help tempt some people back at the margin. The chancellor will lower national insurance contributions by two percentage points (for non-UK readers, this is another form of income tax, but is more limited). The cut will be made from January, usually soon, but again, highlighting the pressure on the government. The self-employed will also enjoy some savings with reductions in contributions, and there was also a generous uprating of pensions and benefits.

In addition to the carrots, the government has decided to use a stick to tempt people back to work. The chancellor announced plans to reform Work Capability Assessment – likely to make it more difficult for individuals to claim benefits for being sick or disabled. Moreover, mandatory work placements are to be offered, and if refused after a period, benefits will be stopped.

This may persuade some to retrain and help find work that better suits their ability to work, but a fundamental problem in the UK is the lack of capacity in the national health service (NHS) to treat those not well enough to work. As of this month, there are nearly 7.8 million people waiting for hospital treatment, compared to just over 4.4 million in January 2020. More investment in the capacity of the NHS would have likely had a greater impact on labour participation.

The Autumn Statement assumes improved public sector efficiencies and reduced spending: is this believable?

Plans for departmental spending run for another fiscal year before a new multi-year spending review is required. The OBR estimates that annual growth in overall resource spending will rise by 0.9% in real terms, down from 1.1% at the time of the Budget. This is due to overspends, mostly on staffing costs, but also due to higher inflation.

Because certain departments have their budgets protected, others will likely see significant reductions. For example, between 2025/26 and 2028/29, NHS England will see an annual average rise of 3.6%, while defence spending will rise by 1.8%. However, core schools spending will fall by 1.2% per annum, and other departments will average a decline of 2.3% per annum. Reduced spending on education is unlikely to help raise long-term productivity.

The Government plans to raise public sector productivity to counter the lower growth in departmental spending. The hope is to raise productivity by five per cent, which would return it to pre-pandemic levels. The OBR estimates that this would be the equivalent of £20 billion of extra funding. Of course, as has been shown in the past, assumptions like crackdowns on tax evasion rarely yield the savings promised by forecasts.

As the OBR points out, governments have historically failed to hit their spending targets, potentially overstating the amount of fiscal headroom used for the latest round of tax cuts.

In terms of welfare spending, there were some populist giveaways, but also some omissions. For example, Universal Credits (benefits allowances) will be increased by 6.7% from April, while the freeze on housing benefits will be removed, and the allowance will be lifted to 30% of local rents. The latter is long overdue as rising rents have forced many families on low incomes to re-locate to cheaper homes. The Government triple-lock for state pensions will be enforced, raising payments by 8.5% from April, in line with average earnings.

Other measures include all alcohol duties frozen until August 2024, but the duty rate on tobacco products will rise by 2% above RPI inflation (currently 6.1%), with hand-rolled tobacco rising 12% above RPI inflation.

Fuel duties were cut by five pence per litre in March for the next year, but there was no mention of fuel duties at all in the Autumn Statement. The OBR assumes that the temporary cut will be reversed in 2024, and the fuel duty escalator would return. This assumption is incorporated in the fiscal headroom calculation, and is again, unrealistic under this government.

Is the Government really stimulating growth?

Overall, the OBR estimates that the Government’s policy decisions will directly pump £21 billion into the economy this financial year and next (relative to previous plans). £7.6 billion will come from additional public spending, and £13.3 billion will come from tax cuts. However, when adjusting for the economic cycle and interest payments, we find that the true impact of fiscal policy will be contractionary in each year. The fiscal impulse, a measure of the impact of fiscal measures on economic growth, is very negative, even in this year and next when the economy is growing below trend (chart 4).

Charts showing fiscal impulse and PSNB as % of GDP

The fiscal impulse is calculated by taking the annual change in the cyclically adjusted primary deficit, which is the deficit excluding the impact from the economic cycle and interest payments. As shown in chart 5, higher interest rates mean a growing share of annual public borrowing going towards interest payments. But the main driver of the fall in the annual deficit is the cyclically adjusted primary deficit. This is mostly driven by past tax increase, especially the decision to freeze tax thresholds, which are causing fiscal drift – more people being dragged into higher tax brackets, as they are not uprated by inflation or earnings growth. Another way to look at it is that the chancellor has taken a loaf, and offered to return a couple of slices of bread.

What are the consequences for the gilt market?

Based on the OBR’s forecast, the UK Debt Management Office (DMO) published its revised debt remit. The central government net cash requirement is expected to rise to £159.5 billion this financial year, before falling gradually to £93.1 billion by 2028/29. However, total gross issuance of gilts has been revised up by £25.3 billion over the forecast horizon. This means a greater supply of government bonds being sold to the private sector, which if all else remains equal, should mean higher yields and interest payments for the government.

This is indeed anticipated in the OBR’s forecast, which shows the effective interest rate on conventional gilts rising from 2.2% this financial year to 3.8% by 2028/29.

Importantly, while annual debt issuance is falling in coming years, the sale of gilts by the Bank of England back to the private markets as part of the reversal of its quantitative easing (QE) policy, means that the supply of gilts this financial year could be at its highest share of national income as in 2009, during the global financial crisis (chart 8). Our estimate for BoE gilt sales is conservative at £80 billion per year, with the risks skewed towards an acceleration in the future.

Autumn Statement 2023

Conclusions: what next for growth, public finances, inflation and rates?

  • The Autumn Statement proved more eventful than expected, highlighting the pressure the Government is under as it approaches a general election in 2024.
  • The economic outlook has worsened, but a better-than-expected outturn for public finances helped give the Government some room to manoeuvre, even if some of the assumptions on productivity gains are questionable.
  • Policy changes announced this round are mildly stimulative, and are worth 0.3% of GDP this financial year, and 0.5% of GDP next. However, as highlighted by the analysis on the fiscal impulse, policy remains contractionary overall.
  • As for inflation, claims by the Government that policies announced help reduce inflation are brave. Some of the smaller policies to boost investment could pay off in the medium term, while the move to full expensing of capital expenditure is likely to reduce investment in the near term.
  •  Above-inflation increases for the minimum wage, benefits, the state pension, and the cuts to personal taxes are meant to help with the “cost of living crisis”, but will likely boost demand, and add to near-term inflation pressures. Indeed, the latest news on household energy bills is that the government cap on the average tariff charged will start to rise again in January.
  • As for the BoE, despite a 10 percentage point rise in the probability of a further rate rise since the Autumn Statement (to 20% by March 2024 based on OIS options markets), we doubt there will be much of a reaction by rate setters. Indeed, if our forecast of recession proves to be accurate, then interest rates may start to fall in the first half of next year – ahead of the BoE’s guidance and current market expectations.
  • A recession would also provide good cover for further fiscal stimulus at the 2024 Budget. Could we finally see the big cuts tax cuts that Conservative Party supporters have been calling for? Cuts to income taxes, inheritance taxes and corporation taxes? Some of their wishes will probably be granted, but the squeeze on public spending required to make these a reality may be too great to deliver all of those aspirations.

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Authors

Azad Zangana
Senior European Economist and Strategist

Topics

Economics
Economic views
UK
Growth
Interest rates
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