Productivity growth twitchy in wake-up call for OBR and Reeves
Productivity levels stuttered in the third quarter of the year, an initial estimate has shown, subverting the Chancellor’s hopes of boosting output in the UK economy.
The Office for National Statistics (ONS) said on Thursday morning that quarterly growth in output per hour rates was 0.7 per cent, the highest level since the end of 2024.
But the output per worker growth rate was just 0.2 per cent, with ONS analysts claiming that the “underlying weakness in UK productivity continues”.
Over a one-year period, productivity growth in output per hour was 1.1 per cent. Compared to pre-pandemic levels in 2019, productivity on the metric was 3.1 per cent higher.
ONS data specialists said it was “important to not over-interpret” a stabilisation of annual productivity growth of around one per cent to near trends seen between 2009 and 2019.
Fresh numbers on the output levels in the UK economy may alarm Chancellor Rachel Reeves and Treasury officials ahead of this year’s Budget.
While HSBC economist Elizabeth Martins said “a small cyclical recovery in productivity may be in progress”, new data was unlikely to sway the Office for Budget Responsibility (OBR) on its expected productivity downgrades ahead of the Budget.
“Eking out 0.1 per cent GDP growth with 0.1 per cent fewer workers is indeed a productivity gain – though the outlook from here is unclear, and the evidence is too thin to suggest any last minute rethink by the OBR.”
OBR’s productivity puzzle
The OBR warned earlier this year that its productivity forecasts were failing to meet reality.
In one of its comments in its March fiscal report, it said that growth in the UK workforce meant output per hour worked in 2024 was 1.3 per cent lower than it had forecast after last year’s Budget.
It said trend productivity growth would average at one per cent a year in its central forecast.
OBR officials added that, if 0.3 per cent trend productivity growth persisted as in post-pandemic times, Reeves could face a fiscal hole of around £30bn by 2030 as the current budget would be in deficit of around 1.4 per cent by 2030.
The OBR then argued it left its medium-term forecasts on productivity unchanged due to the risk of “data volatility” and “temporary factors”.
But since the Spring Statement in March, the OBR has announced it was conducting a broader supply side review, which has long been taken as a sign that it was set to drastically downgrade its forecasts.
City analysts have suggested that a 0.3 percentage point decrease to productivity trend forecasts could alone create a £20bn shortfall for Rachel Reeves if she wishes to stick to her fiscal rules.
The key rule relating to the Chancellor’s headroom states that day-to-day spending should match tax receipts in the last year of the OBR’s forecast.
Reeves ‘can reasonably feel aggrieved’
Over recent weeks, Reeves has blamed the OBR’s expected productivity downgrade on economic hits during the previous Conservative government, including Brexit, the pandemic and “austerity”.
In an interview signalling she would break Labour manifesto commitments not to raise income tax, she told the BBC earlier this week: “Last year I had to address the black hole in the public finances. This year we have had the new challenge of the Office for Budget Responsibility downgrading growth forecasts.”
Reeves and other Labour MPs have also argued that the timing of the productivity review may be unfair and that the OBR should have chosen to change forecasts before the last General Election.
Economists on CityAM’s Shadow MPC, speaking independently of their organisations, agreed a downgrade was fair and unsurprising but questioned the timing of the expected changes to forecasting.
“A downgrade is long overdue, though the Chancellor can reasonably feel aggrieved about the timing,” the economist Julian Jessop said.
Others pointed out the Chancellor should have left herself with a larger headroom.
“The Chancellor’s predicament largely stems from the fact that she left herself just £9.9bn of headroom against her fiscal mandate in March,” Ruth Gregory, deputy chief UK economist at Capital Economics, said.
“Had she left the £31bn average that previous Chancellors have had against their respective fiscal rules between 2010 and 2022, then we suspect she would have been left still meeting her fiscal mandate with around £6bn to spare.