The British government is cutting spending and raising taxes in an effort to build a hefty war chest to cope with the many uncertainties surrounding Brexit.
Philip Hammond, the Chancellor of the Exchequer, unveiled the government's annual budget on Wednesday, just days before Britain is set to begin the process of leaving the European Union. It was the first budget since the country voted to leave the EU last June, and Mr. Hammond stressed that the government wants to lay a solid financial groundwork as it heads into negotiations with the EU this month.
"As we start our negotiations to exit the European Union, this budget takes forward our plan to prepare Britain for a brighter future. It provides a strong and stable platform for those negotiations," Mr. Hammond told the House of Commons.
Britain's economy has defied most expectations since the referendum, with economic growth higher than expected, real wages rising and unemployment dropping to an 11-year low. The government's Office of Budget Responsibility revised its economic growth forecast for 2017 to 2 per cent, up from 1.4 per cent last fall. The stronger economy, coupled with the spending and tax changes in the budget, mean the annual deficit will also drop to the lowest level in 10 years, the OBR added.
However, there are clouds on the horizon as Brexit looms. Business investment is slowing and much of the recent economic growth has been fuelled by consumer spending, which has been outpacing income rises.
"This will have contributed to recent strength in tax revenues, but consumer spending growth cannot continue to outpace income growth by such a margin indefinitely," the OBR warned. As a result, the agency lowered its forecast for gross domestic product growth in 2018, 2019 and 2020 to 1.6 per cent, 1.7 per cent and 1.9 per cent respectively. The economy won't get back to 2 per cent growth until 2021.
The OBR also stressed that all economic forecasts during the Brexit process are subject to wide variations. "There is also considerable uncertainty about the economic and fiscal implications of different outcomes, even if they could be predicted," the OBR said.
Notably, the agency's forecast comes with several key assumptions including accepting the government's belief that it will take just two years to conclude the exit negotiations and reach a new comprehensive trade deal with the EU. Few experts believe that is possible; they cite the Canada-EU trade deal which took eight years to negotiate and is still not completely ratified.
The OBR also doesn't take into account any lump-sum payment Britain may have to pay the EU on departure, such as pension obligations. Some researchers have pegged the figure as high as €60-billion ($85-billion).
Mr. Hammond's budget contained no major spending plans but he did increase spending on social welfare, technical training and digital technology items such as fibre broadband and a 5G mobile tech hub. Tax hikes included raising levies on alcohol, gambling, tobacco and soft drinks and higher national insurance contributions by self-employed people.
While the budget was a largely "wait-and-see" affair, some economists said Mr. Hammond's road ahead won't be easy given Brexit.
"The most striking thing is that the chancellor has admitted Brexit may hurt the economy more than previously predicted," said Lucy O'Carroll, chief economist at Aberdeen Asset Management. "There's an improvement in the fiscal numbers this year, but it isn't expected to last.
"The growth outlook is forecast to be significantly weaker between 2018 and 2020. This is critical. It means that the chancellor's much-talked-about Brexit war chest – or borrowing headroom – is slightly smaller than previously projected. Far from increasing to £60-billion – as some commentators had speculated – it's now expected to be £26-billion."
RBS Economics cited lagging productivity growth as a key challenge as well, pointing out in a report that it is "no longer a problem that can be shrugged off with a 'it'll be alright in the end.' The economy needs to be on a permanent war footing with regards to combatting poor productivity."
Lucy Jeanne Neville-Rolfe, a minister of state for finance, said the budget was designed to prepare the economy "so that it is fit and having enough flexibility so that you can do extra things if the need arises, even on a short-term basis."
She also dismissed concerns about the uncertainty caused by Brexit. "I think you have to learn to deal with uncertainty," she said after the budget in a briefing with reporters. "I come from business and although one's always saying, well, certainty is the most important thing, in fact it's certainty and success.
"And, you can take a certain amount of uncertainty if you're confident you're on the right road ahead. … That's what we're trying to make sure is the direction of travel. Of course there is always uncertainty so there are going to be ranges and you'll have to operate within ranges. But I think that's fine."