OBR confidence on inflation a ‘mug’s game’

The Office for Budget Responsibility’s confidence in predicting inflation in 12 months’ time has been described as a “mug’s game” by a top-quartile UK equities manager.

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Delivering the Spring Statement on Tuesday, chancellor Philip Hammond (pictured) referred to the OBR’s second report for the fiscal year 2017/18 which expects inflation, currently at 3%, to fall back to the 2% target over the next 12 months.

The OBR’s March Economic and Fiscal Outlook 2018 said: “CPI inflation reached 3.1% in November 2017, which we expect to have been its local peak. We assume that the unwinding of last year’s sterling-driven rise in import prices will bring inflation down to around 2% relatively quickly and that it will remain close to that level.”

However, Paul Mumford, fund manager at Cavendish Asset Management, said while he was loathe to question a forecast from the “ever-reliable” OBR, he described its confidence on inflation as “quite curious”.

“Predicting inflation 12 months out in the current environment is a mug’s game,” he added.

“A lot will depend on what happens with sterling and oil prices, and with retailers suffering so much the temptation to put up prices to mitigate lower volumes will be strong, and that’s before you consider the impact of the incoming living wage. It could easily swing the other way.

Favourable outlook

Elsewhere, Hammond’s statement noted the OBR has also revised its growth forecast for 2018 from 1.4% to 1.5%. The forecast for 2019 and 2020 is unchanged at 1.3%, before picking up to 1.4% in 2021 and 1.5% in 2022.

The nation’s borrowing is forecast to be £45.2bn this year, 2.2% as a percentage of GDP in 2017/18, which is £4.7bn lower than forecast in November. This is expected to drop to 1.8% in 2018/19, 1.6% in 2019/20, then 1.3%, 1.1% and finally 0.9% in 2022/23.

Hammond said the more favourable outlook for borrowing means the debt forecast is nearly 1% lower than in November. This is expected to peak at 85.6% of GDP in 2017/18, before falling to 85.5% in 2018/19, then 85.1%, 82.1%, 78.3%, and finally 77.9% in 2022/23.

This is the first sustained fall in debt in 17 years, Hammond noted, describing it as a “turning point in the nation’s recovery from the financial crisis of a decade ago”.

“Light at the end of the tunnel,” he added.

Muted reaction

Sterling rose after the announcement, but Old Mutual Global Investors head of UK equities Richard Buxton said this was likely in reaction to the US dollar falling on the news that US secretary of state Rex Tillerson was being fired, rather than anything material contained in Hammond’s statement.

Buxton added: “In terms of economic growth, there were some positive, albeit very modest announcements. Economic growth, it appears, is not quite as bad as we have been led to believe. Growth for 2017 came in at 1.7% versus an estimated 1.5%, and forecasts for subsequent years were upgraded.

“Add to that the fact that employment levels remain robust, debt is coming down as a proportion of GDP, and it is difficult not to come to anything other than the conclusion that growth in UK plc will be ok. Nothing spectacular, but nothing disastrous.”

Stock market reaction was muted reflecting the stripped-down nature of the statement and the lack of any clear policy changes affecting individual companies.

Russ Mould, investment director at AJ Bell, said: “Even if the stock market looks to be shrugging, the debt markets look to be pleased, judging by how the yield on the 10-year gilt has fallen back below 1.50%, well below February’s 1.65% high.

“The OBR’s minor cuts to its estimates for inflation for 2018/19 and 2019/20, to 1.8% and 1.9%, may help a little on this front, too, also giving the Bank of England breathing space when it comes to its latest interest rate decision next Thursday.”

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