OBR risks being ‘unreasonably pessimistic’ as Reeves set to be given leeway
The Office for Budget Responsibility (OBR) risks being “unreasonably pessimistic” if it decides to downgrade productivity growth trends by more than 0.1 percentage point, fresh analysis has indicated, in what could hand Chancellor Rachel Reeves some extra leeway at this year’s Budget.
The fiscal watchdog is widely expected to downgrade productivity forecasts as part of its supply-side review, basing figures on low productivity levels under the previous Conservative government to the frustration of the Labour government.
A downgrade to productivity forecasts by 10 basis points alone could entirely wipe out Reeves’ £9.9bn headroom and risk leading to further tax hikes, adding to higher borrowing payments than expected as well as costs from policy U-turns.
But fresh modelling by Pantheon Macroeconomics has suggested that productivity levels have been better than OBR forecasts on some measures.
It said recent growth data revisions by the Office for National Statistics (ONS) pointed to higher official output-per-hour levels than expected.
Economists also said productivity growth’s dependence on the Labour Force Survey (LFS), an “unreliable” measure taken by the ONS, could be looked over.
Pantheon Macroeconomics analysts Rob Wood and Elliott Jordan-Doak said productivity growth based on HMRC data hit 2.1 per cent on an annual basis in the second quarter of the year, higher than when data from the LFS was used.
They also said productivity growth in the second quarter of the year based on both ONS and HMRC payroll data was higher than the OBR forecast while there were signs of optimism for productivity growth to rebound in the coming years.
“It seems unreasonably pessimistic to us to assume productivity will remain almost stagnant forever, matching the trend over the past 15 years,” Wood and Jordan-Doak wrote in a new report.
“AI has the potential to be the next ‘general-purpose’ technology that boosts efficiency. Moreover, strong UK business investment in the first half of 2025, and signs from rising corporate borrowing that investment will keep growing, bode well.”
They said that while productivity in the second quarter of the year remained one percentage point below trends seen between 2010 and 2023, productivity trends should only be forecast at a slightly lower level.
Reeves to face ‘£25bn fiscal hole’
A 0.1 percentage point reduction to productivity a year has led Pantheon to estimate the fiscal hole awaiting Reeves to be worth £25bn, a slightly more optimistic estimate than forecasters at Capital Economics and the National Institute of Economic and Social Research (NIESR).
Higher interest costs on debt servicing and welfare U-turns are likely to force Reeves to raise revenue.
Economists are also weighing in on which taxes the Chancellor should hike, with a break from Labour manifesto commitments not to raise income tax or VAT seen as the preferred option.
But Labour ministers could yet find some savings through welfare reforms. Proposed changes to unemployment benefits could save up to £3bn, analysis by the Institute for Fiscal Studies has shown.