Pound falls as OBR says economy set to shrink by 2% in long recession
The Office for Budget responsibility has said the recession is set to last ‘just over a year’
The pound fell sharply on Thursday after Jeremy Hunt’s autumn statement revealed a painful era of austerity ahead while the fiscal watchdog forecast Britain’s economy will shrink by 2% over a lengthy recession.
It was the second time in a row that the currency fell against the US dollar after a Budget, losing more than 1% by the end of the day’s trading.
Shares also fell, the FTSE 100 Index 0.7% closing lower at 7301.8, while gilts – UK government bonds, that were at the centre of the recent mini-Budget market chaos – edged up slightly in a sign of investor concerns over the economic prospects.
Mike Owens, senior sales trader at Saxo UK, said that while the pound has recovered since Rishi Sunak became prime minister, the chancellor’s budget “nevertheless paints a bleak picture of the state of the UK economy”.
Government debt is set to balloon £400bn higher than previously expected, warned the fiscal watchdog as it unveiled a bleak outlook for the UK economy.
The Office for Budget Responsibility (OBR) said the economy is already in recession and will shrink further next year because of sky-high inflation.
It said squeezed incomes, higher interest rates and tumbling house prices – which it expects to drop by 9% by 2024 – are all set to contribute to a recession lasting “just over a year”.
The official forecaster downgraded previous projections that the economy would actually grow by 1.8% in 2023 to a fall of 1.4% for the year.
Growth expectations for the following year were also downgraded in the face of continued inflationary pressure.
It has, however, slightly upgraded the total economic growth expected this year to 4.2% from 3.8% in the March statement.
The OBR has also predicted that inflation will hit an average rate of 9.1% this year and 7.4% in 2023.
Previously, forecasts had indicated inflation of 4% next year.
The Bank of England has repeatedly hiked interest rates during this year in an effort to drag down inflation, with rates jumping to 3% earlier this month.
The OBR said higher interest rates had a significant impact on government debt, which it said is now expected to be £400bon higher – roughly 18% of the size of UK GDP – in 2026-27 than it forecast in March.
Unemployment is also expected to jump over the next two years, according to the forecasts.
The rate of unemployment is set to lift from 3.6% to 4.9% in the third quarter of 2024.
This would mean a 505,000 increase in unemployed individuals from 1.2 million now to a peak of 1.7 million.
The OBR’s latest forecasts have been long awaited after the official forecasting body was not used during the September mini-Budget, led by former chancellor Kwasi Kwarteng.
Economists partially linked the shock to the pound and bond yields following the mini-Budget announcement to a lack of visibility on the impact of the previous government’s fiscal plan.
There is a high probability that real GDP outturn will prove lower than the OBR’s forecast, while inflation remains stickier in the short term, adding to the government’s expense
On Thursday, some economists questioned the outlook from the OBR, which was largely more upbeat in the medium term than the Bank of England’s latest economic forecasts.
Martin Beck, chief economic adviser to the EY Item Club, said: “With the OBR delivering a poor prognosis for the economy’s prospects, the fiscal position is expected to face challenges accordingly, with substantial upward revisions to public borrowing over the next five years.
“But the EY Item Club thinks the OBR’s forecast is potentially too downbeat.
“The OBR’s numbers are conditioned on interest rates rising to 5%, a level which the official forecaster predicts would contribute to inflation falling below zero in 2025.
“A lower rate assumption, and one consistent with the Bank of England’s 2% inflation target, would mean a better growth outlook.”
Yael Selfin, chief economist at KPMG UK, said: “The revised set of targets outlined by the chancellor in the autumn statement to secure markets’ confidence in the sustainability of UK public finances may not be as easily met, given that the OBR forecasts have been relatively generous.
“There is a high probability that real GDP outturn will prove lower than the OBR’s forecast, while inflation remains stickier in the short-term, adding to the government’s expense.”