Budget Report 24 March 2010

The Economy

The recession has exerted enormous pressure on both businesses and consumers. Businesses have struggled to obtain credit; consumers have tightened belts. Here we look at some of the consequences of the worst economic downturn in generations.

Public finances

One of the major problems facing the UK economy is the vast scale of public borrowing; money borrowed in order to bolster failing banks, to ensure the continuing lubrication of the wheels of the economy (through the Bank of England’s quantitative easing programme) and to support public sector employment. Net Government borrowing is currently in excess of £850 billion or 60 per cent of GDP; the planned budget deficit for the year was £178 billion although the revised Budget forecasr is now £167 billion. It is a debt, however essential its role in the short term, that will have to be repaid through (1) increased taxation – some, the upcoming 1 per cent rise in national insurance contributions for example, aimed at businesses – and through (2) public spending cuts in the medium and long term. Those cuts may pare as much as 2 per cent off the GDP. A further option is (3) the sale of public assets.

Consumer spending

The Chancellor’s decision to reduce the standard rate of VAT from 17.5 per cent to 15 per cent from 1 December 2008 to 31 December 2009 helped, but consumer spending on large items such as furniture and white goods plummeted. That measure of the vitality of the economy – sales of new cars – registered such dismal figures that the Chancellor also introduced the scrappage scheme: a £2,000 discount for those who traded in old cars for new ones. But spending habits showed a distinct change across the board. For example, cut-price supermarkets enjoyed a boom of 18 per cent in business.

Saving

The economics of a recession demand that people keep spending; the human perception of a recession demands that people stop spending and start saving, or at least start paying off debts. Such has been the case.

The number of households that are using their money to repay debts or to boost their savings is on the increase. Worries over prospects for the UK economy and the effects of the forthcoming rises in taxes have encouraged more people than ever to save rather than to spend, official figures suggest.
 

The level of earnings that is being saved in banks and building societies is at its highest for almost a decade. In the third quarter of 2009 consumers repaid £5 billion more than they borrowed, according to the Office for National Statistics (ONS).
 

While spending edged up by just 0.3 per cent in the same period, the gap between household income and the average amount that households spent rose to 8.6 per cent. Much of that money will have been used to repay debts or increase savings accounts.

Inflation

Those savers, though, have found themselves penalised by historically low official interest rates and by rising inflation.

According to the ONS, the Consumer Price Index for February stood at an annual rate of 3.0 per cent, down from 3.5 per cent in January.

As a result, inflation is set to have a knock-on, adverse effect on the level of returns that savings accounts deliver, at least in the short term. For basic rate taxpayers to gain a real return on their money, they will require an account that pays a minimum of 3.75 per cent interest. For higher rate taxpayers, that figure climbs to 5 per cent.
 

Taking the latest inflation rate and tax into consideration, the actual return on an average no notice savings account in February was 2.3 per cent.