Chancellor Philip Hammond has been dealt a blow ahead of next month’s Budget after the economic watchdog warned overly optimistic productivity forecasts will slash its outlook for UK growth.
The Office for Budget Responsibility (OBR) – whose forecasts form the basis of the chancellor’s Budget decisions – has admitted it is set to “significantly” lower its predictions for the UK’s productivity growth over the next five years in next month’s forecasts.
In its Forecast Evaluation Report, the OBR said the productivity downgrade is expected to hit growth and weaken the public finances outlook – which is is set to decimate the £26 billion headroom Mr Hammond had put faith in to ease the economy through Brexit.
Robert Chote is the chairman of the Office for Budget Responsibility (PA)
The OBR warned: “While we continue to believe that there will be some recovery from the very weak productivity performance of recent years, the continued disappointing out-turns, together with the likelihood that heightened uncertainty will continue to weigh on investment, means that we anticipate significantly reducing our assumption for potential productivity growth over the next five years.”
It added: “It is highly likely that the downward revision to productivity growth will dominate in terms of its effect on cumulative GDP (gross domestic product) growth over the forecast horizon and the associated consequences for the budget deficit.”
While better-than-expected borrowing since its March 2016 forecasts and ongoing falls in unemployment would help strengthen the Government’s books, the OBR said “the downward revision to productivity growth is likely to have the largest quantitative impact”.
The Treasury said it was working to fix the so-called productivity puzzle.
A spokesman said: “Productivity has been a long-standing challenge for the UK economy, which is why we are focused on boosting our performance to deliver higher living standards and build an economy that works for everyone.”
The OBR said productivity had consistently fallen short of its forecasts, having dropped by 0.5% in the first financial quarter of the year and 0.1% in the second.
It had forecast in March that productivity would rise slowly to reach 1.8% in 2021, but said it has averaged just 0.2% over the past five years.
This is far short of the 2.1% a year rise seen in the pre-financial crisis era.
Productivity refers to the amount of work produced either per worker or per hour worked.
The OBR said there have been many explanations for the surprisingly low productivity, including labour hoarding, banking sector impairment, very low interest rates and weak investment.
It said “some arguments for the post-crisis weakness being temporary now appear less plausible”.
But the OBR offered some cheer as it said Government borrowing had been lower than it predicted – £2.8 billion less than it forecast in March – thanks to bumper tax receipts after stronger company profits and higher employment.
The Office for National Statistics (ONS) also recently made a host of downward revisions to last year’s budget deficit, which the OBR said would be “beneficial”.