The Chancellor had less fiscal room for manoeuvre than some had expected, so needed to raise extra revenue to finance modest giveaways. His key announcements have a clear political rationale but lack economic logic. The fiscal plans continue to rest on an assumed large cut in current spending of questionable deliverability.

• The most costly measure is a further increase in the personal allowance, but a rise in the NI threshold would have been a better way of targeting low earners.

• The Chancellor also spent money on a new savings income allowance and an ISA subsidy for first-time homebuyers. The former further complicates the taxation of savings, while the latter will mainly boost house prices rather than housing supply.

• These measures are paid for partly by a further raid on the banks, which will be passed on in lending and deposit rates. In addition, the lifetime pension allowance is reduced again, discouraging long-term saving. The Chancellor, instead, should have taken the opportunity provided by lower oil prices to raise fuel duty.

• The underlying borrowing path has been revised down by less than expected, with lower debt interest and welfare costs offset by a fall in North Sea revenues and weaker stamp and excise duties.

• The debt to GDP ratio now begins falling in 2015-16, a year earlier than before. However, this is achieved by bringing forward asset sales, in the form of UK Asset Resolution mortgages and Lloyds shares – the public sector’s net wealth is unchanged.

• As expected, the Chancellor raised his public spending assumption for 2019-20, so that expenditure as a share of GDP now bottoms out just above its level in 1999-2000, rather than falling to its lowest since the 1930s. This undermines a key Labour attack line with one keystroke.

As before, the Chancellor’s claim that the deficit is on a smooth glide path to elimination by 2018-19 rests on an ambitious cut in the share of current spending in GDP in the early years of the next parliament. The share is projected to fall by 3.7 percentage points of GDP in the three years to 2017-18, a pace of reduction previously achieved only in boom conditions in the late 1980s – see chart.  A major weakness of the current system of fiscal planning is that the OBR must incorporate the government’s spending assumptions in its forecasts, despite an absence of detail and widespread doubts about their achievability. Mr Osborne referred to the tendency of former Chancellors to fudge their figures but he is equally guilty of fantasy forecasting.

The real yield on intermediate-maturity government bonds in the Eurozone has moved beneath the minimum level reached in the US in 2012, ahead of a significant market sell-off.

The real yield is defined here as the average redemption yield on 7-10 year government bonds minus the consensus longer-term inflation forecast. The latter is sourced from the quarterly surveys of professional forecasters conducted by the Philadelphia Fed and ECB*.

Using month-end data, the US real yield reached a low of -1.2% in May 2012, ahead of the launch of QE3 in September. This reflected a nominal yield of 1.3% and expected longer-term inflation of 2.5%.

The Eurozone real yield is currently -1.3%, reflecting a nominal yield of 0.5% and a longer-term inflation forecast of 1.8%.

The US real yield returned to positive territory in July 2013 as the nominal yield rebounded, even though QE3 remained in full swing until December. 7-10 year Treasuries suffered a price reduction of 9.6% between May 2012 and December 2013, when the Fed announced its first “taper”. Including coupon income, the loss was 5.4%.

The view here is that the ECB has overreacted to a dubious deflation scare and monetary conditions are now excessively loose, evidenced by a surge in narrow money and rapid euro depreciation**. QE had limited economic impact in the US, UK and Japan but may prove more powerful and distortionary when combined with a negative interest rate on excess bank reserves. Eurozone bond investors may be running greater risks than their US counterparts in 2012.

*The forecast horizons in the Philadelphia Fed and ECB surveys are ten and five years respectively. The Eurozone yield is calculated by Datastream and covers 12 markets.
**M1 rose at a 14% annualised rate in the three months to January. The Bank of England’s euro trade-weighted index is down by 10% since end-December.

Contrary to claims that a strong US dollar is tightening liquidity conditions, six-month growth of global* real narrow money appears to have risen further in February, suggesting solid second-half economic prospects.

The US, China, Japan, India and Brazil have released February monetary data, together accounting for about 60% of the aggregate tracked here. Assuming stable six-month changes elsewhere, the global measure should reach its highest level since December 2011 – see first chart.

The rise in global real money growth over October-January reflected an energy-driven fall in inflation. The February increase, by contrast, was due to faster nominal expansion – second chart.

Real money growth surged in the G7 but fell back in the emerging E7, pushing the G7 / E7 gap to its highest since January 2012 – third chart. The G7 rise was mainly due to the US – see previous post. Japanese real money growth firmed but continues to lag the Eurozone / US. February Eurozone data will be released on 26 March.

E7 growth has been held down by contractions in Russia and Brazil. Real money is expanding moderately in China and India. The strongest growth recently has been in Mexico and Korea – fourth chart.

*G7 plus emerging E7.