Balanced Budget Policy Cuts Britain’s Growth in Half
Policy + Politics

Balanced Budget Policy Cuts Britain’s Growth in Half

REUTERS/UK Parliament

British finance minister George Osborne turned to the Bank of England on Wednesday to help galvanize a stagnant economy which he said would grow this year at just half the rate previously expected. In his annual budget speech to parliament, Osborne stuck to his austerity drive in the face of intense calls for a change of course, but said monetary policy could do more to help Britain get out of its rut of near-zero growth.

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The central bank’s inflation target would remain at 2 percent a year, but that was not enough on its own, he said. "As we’ve seen over the last five years, low and stable inflation is a necessary but not sufficient condition for prosperity," Osborne said to jeers from the Labor opposition, which wants more spending to help growth.

Osborne said the country’s economy was now expected to grow 0.6 percent this year, half the rate predicted just three months ago, but he vowed to stick to the course on austerity. "It is taking longer than anyone hoped, but we must hold to the right track," he said.

Britain’s meager growth projection is better than that for the neighboring euro zone, which is expected by many to contract over the year. But it pales against most of the rest of the world, including the United States, which is seen growing closer to 2 percent over the year.

Despite a slump in opinion polls, Osborne and Conservative Prime Minister David Cameron have stuck to their push to fix Britain’s budget deficit and rising public debt, hoping for a recovery before they fight for re-election in two years time.

But Britain’s economy may already be back in a recession again after a contraction in the fourth quarter of last year, while rising inflation is hurting households. The pound has also been falling. It is down around 7 percent against the dollar and 5.5 percent against the euro this year. Among the measures announced by Osborne on Wednesday were cuts to business taxes and incentives for homebuyers.

Osborne paved the way for potentially big changes at the Bank of England, asking the central bank’s top policymakers to report back to him in August about the merits of setting "intermediate thresholds" for monetary policy.
Such changes might make the Bank of England operate in a way similar to the U.S. Federal Reserve which late last year said it would keep interest rates near zero unless unemployment and unemployment and inflation breached specific levels.

The response in August by the bank will be one of the first tasks awaiting its next governor, Mark Carney, currently the head of the Bank of Canada. Under Carney, the Bank of Canada spelled out how long it would keep interest rates low, something the Bank of England doesn’t do now but may do under its new remit. Carney and the current governor, Mervyn King, both agreed to the new remit.

It also recognized the potential need for further "unconventional monetary policy instruments," such as the massive bond-buying program already undertaken. Another review of the mandate will be carried out before the end of 2019. After an initial fall, sterling rose against the dollar but was weaker against the euro. British government bond futures pared losses.

"The change to the remit doesn’t go quite as far as some … had speculated, and therefore the reaction from the currency and gilts has reflected this," said Philip Shaw, an economist with Investec. "It does, however, potentially give the (Bank) more flexibility to ease monetary policy further."

Shortly before Osborne began speaking in parliament, some details of his market-sensitive statement were leaked on the Internet, prompting goading by the opposition. Forecasts by Britain’s budget watchdog showed growth was expected to pick up to 1.8 percent in 2014, Osborne said.

That was also lower than the watchdog’s December forecast.

Osborne said Britain was on track to eliminate its underlying budget deficit by the 2016-17 fiscal year, one year before the end of a rolling five-year horizon over which the government aims to balance the budget. But a secondary target of getting debt to fall as a share of GDP would not happen until 2017-18. That was a year later than forecast in December, when it was also pushed back by a year.

Britain’s fiscal watchdog said one measure of the budget deficit in the fiscal year ending this month put the shortfall at 7.4 percent of GDP, among the highest in the European Union. France’s government has been criticized for not being tough enough with its budget which is expected to post a deficit of 3.7 percent of GDP this year.

With little sign of strong growth any time soon that would help restore its fiscal health, Britain could suffer further downgrades of its credit rating. Moody’s stripped Britain of its prized triple-A rating last month. On Wednesday, Moody’s said it expected its assessment of the new budget to underpin its stable outlook on its lowered Aa1 rating for Britain, meaning little chance of a further cut.

Osborne announced several tax changes including cuts in corporation tax to 20 percent in 2015 and on employment taxes for businesses. Individuals will also not pay tax on their first 10,000 pounds of income from 2014, a year earlier than previously expected.