How close is the UK to the edge? (updated)

In his autumn statement, George Osborne warned that, without his programme of fiscal consolidation, “Britain would have borrowed an additional hundred billion pounds in total [by 2014/15]. If we had pursued that path, we would now be in the centre of the sovereign debt storm.”

But how confident can we be that that storm has been averted? In the city, sovereign risk and an economic downturn are seen as the most important threats to the UK financial system. An economic downturn now seems more than likely, and will be savage if efforts fail to shore up the euro.

What about a sovereign debt crisis in the UK? When asked to name the most important current threat, risk managers for around 70 UK financial institutions now put debt at the top of their list.

I think they’re right to be worried. Even after this week’s downward revisions, the Office of Budget Responsibility expects tax revenues to grow rapidly over the next two financial years – but there’s little prospect of that happening if there’s a sharp downturn.

Imagine, instead, if the government’s income declined in the same way it did after 2008 – that would mean more than £150bn less revenue than expected over two years (a ‘taxation double dip’). Following the Chancellor’s logic, that would be enough to steer the UK straight into a debt storm.

Now you could argue that revenue will prove more robust than it did after 2008 and that’s probably true if the UK sees ‘normal’ economic underperformance. But euro breakup – accompanied by an inevitable banking crisis, massive disruption of exports, lower oil revenues etc. – would take us far beyond normal.

Bottom line: if the euro goes, it probably takes the British government with it. Happy days. Continue reading

Office of Budget Responsibility – laughing stock

I remember being astonished by the rose-tinted specs donned by the UK’s Office of Budget Responsibility (“independent and authoritative analysis of the UK’s public finances”) as as it was created in the run up to the 2010 budget:

We expect the economic recovery to strengthen in 2010 and beyond, as private sector demand continues to pick up. We estimate that trend output will grow at just over 2¼ per cent over the next three years…

From 2011 onwards, GDP is expected to grow at an above-trend rate as the economy rebalances away from consumption towards investment and net exports.

That worked out well, didn’t it? Here’s a graphic showing how badly the OBR got it wrong (Datablog has an interactive version).

Each of the OBR’s forecasts – including the one released today for George Osborne’s autumn statement – has been markedly less optimistic about the near term than its predecessor, while continuing to be sure things will look a lot better in just a few years’ time.

Initially, I put the OBR’s eagerness to please the government down to weak leadership and expected things to improve when the fearsome Robert Chote took charge of the new body. But, if anything, they have got worse. Here’s the OBR’s latest fan chart which shows how bad (good) things could be fir the UK economy, based on errors in previous Treasury forecasts. Looking at it and you’d conclude that – worst case – the UK might lose 2% of GDP next year (dreadful, but nothing like as bad as 2008):

The OBR also makes a big deal of how important it is to “recognise uncertainty” and to “stress test” its assumptions. One stress is (surprise, surprise) further turbulence in the eurozone:

Our central forecast is predicated on the euro area finding a way through its current difficulties, with the effect on confidence, credit conditions and economic activity taking some time to unwind, but with the financial sector returning to a stable position by the start of 2014. In this scenario we consider the implications of the financial sector taking longer to normalise (for reasons either to do with events in the euro area or with domestic factors).

The central prediction, then, is for a two-year quick fix for the euro, which seems highly implausible to me. What about the downside? All we get is a scenario that models “persistent tight credit conditions… for reasons either to do with events in the euro area or with domestic factors.” And that leads to… a blip. Growth is totally unaffected next year (GDP up 0.9%) and is only very slightly lower in the next two years (GDP up 1.6% and 2.3%). After that, life is back to normal.

At a time of maximum danger for the UK economy, we have a fiscal watchdog whose ‘stress’ tests are ludicrously unstressful, because anything harsher “is impossible to quantify in a meaningful way.” It’s like a doctor who suspects her patient is dying of cancer, but focuses on his ingrowing toenail because it’s “easier to see.”

George Osborne promised us a body that would reassure the public. Instead, the OBR has persistently failed to model the forces tearing the British economy apart. His new creation risks becoming a laughing stock if it doesn’t quickly mend its ways.