With strains on the public purse and the need still to keep down the UK’s risk premium after September 2022’s reckless mini-budget, Chancellor of the Exchequer Jeremy Hunt had limited room for largesse in his 15 March budget.
With a technical gross domestic product recession no longer expected, the Treasury’s coffers were around £30bn fuller than expected in Hunt’s 17 November statement, adjusted for definitional changes to student loans. But with financial markets watching, he was right to use no more than two-thirds of it in targeted measures, with the rest put towards short-term fiscal repair.
By preserving previously announced tax rises such as freezing personal tax thresholds, selected spending cuts and a higher corporation tax rate, Hunt is providing further calm after his predecessor, Kwasi Kwarteng, threatened £60bn of unfunded fiscal expansion. To do otherwise would have risked another leap in market interest rate expectations that last November had been the largest inter-forecast jump the Bank of England had seen.
The benefit of prudence, aided by better growth and tax revenue projections than anticipated in November, is to massage down over the forecast period to 2027-28 public sector government debt ratios still close to post-war highs. But they remain excessive and more work is needed to avoid debt becoming troublesome.
Figure 1. The UK could remain the relative growth laggard
Real GDP level re-based (Q1 2007 = 100). Grey denotes US (NBER) recession
Source: Refinitiv Datastream
Hunt did use the windfall selectively to assist demand and ‘break down the barriers’ that prevent people (over 7m adults of working age) from working. These include confirmation of the energy support package’s extension to July after which wholesale gas prices are expected to fall (factored into the BoE’s November forecast), full capital allowances as an offset to the corporation tax rise, promotion of investment zones, increased pension allowances and free childcare for working parents (hoped to attract 60,000 into employment).
But the absence of other measures offers little to lift the UK from the verge of recession. Forecast upgrades based mostly on the relatively mild northern hemisphere winter mean the Office of Budget Responsibility now discounts a GDP recession, with activity falling in Q1 2023 and picking up slightly into 2024. This runs contrary to the more-than-one-year recession the BoE is projecting, and suggests a peak-to-trough GDP fall of about a quarter of the 2.1% expected in Hunt’s autumn statement.
Consumer price index inflation is expected to fall on base effect, lower world energy prices and Hunt’s announcement of pub alcohol and fuel duty freezes: from 10.1% yoy in January 2023 to as low as 2.9% in Q4 2023. This will please Prime Minister Rishi Sunak who has staked his reputation on ‘halving inflation’ by year end. Yet the fall in real household disposable incomes as a result of a higher tax burden (reaching a post-war high in 2027-28) and stagnant growth will be the sharpest two-year fall (a cumulative 5.7%) since 1956 when records began.
These could keep the UK as the growth laggard within major economies. On the current path, returning its real GDP to the pre-Covid-19 peak (Figure 1) is unlikely to happen until mid-2024. So quid pro quo to the Conservative government of putting debt reduction ahead of short-term largesse is handing extra political capital to its opposition.
Keir Starmer, leader of the opposition Labour party, was quick to label Hunt’s budget as a ‘doom loop of lower growth, higher taxes’. And Pat McFadden, shadow chief secretary to the Treasury, gave the reminder that ‘the IMF has forecast us to have among the weakest growth of major industrial countries over the next two years.’
Figure 2. Legacy of slow growth after the 2008 financial crisis is debt build-up
Government gross and net liabilities as a % of GDP, e = estimates, p= projections
(*1998 data; **2000 data)
Source: Organisation for Economic Co-operation and Development, Moody’s Investor Services
Even with the mix of targeted help and fiscal prudence announced on 15 March, UK fiscal borrowing stays high over the medium term. Hunt may have patched up the hole left by Kwarteng – and even shown improvement on his own autumn statement – but the finances have deteriorated noticeably since Sunak’s (chancellor from 2020-22) budget in March 2022. As the OBR admits: ‘The outlook for borrowing has improved materially since November, but remains more challenging than a year ago.’
Compared to March 2022, the OBR now expects the ratio of public sector net borrowing to GDP up to 2026-27 (at an average 3.3% of GDP) to be a cumulative 7.8 percentage points higher (an annual average of 2pp). This is only partly because of its lower (an average 0.8pp less per annum) nominal GDP projections.
Without growth, this could prove troublesome. Net government debt is now expected to peak at 103% in 2023-24, both significantly higher and later than the 96% peak in 2022-23 hoped for in March 2022. As a guide, the OBR expects net debt adjusted for BoE holdings to be 92% in 2023-24. While lower, this ratio is not expected to peak out, at 95%, until 2026-27 as continuation of the Bank’s active quantitative tightening (asset sales) reduces the difference between the two measures.
Either way, today’s debt ratios are around three times Japan’s (34%) when it entered a lost growth decade in the mid-1990s (Figure 2, which uses OECD estimates for consistency). Japan’s debt is held predominantly (97%) by domestic investors less sensitive to yield and foreign currency ratings. Yet, with around 40% of UK market-held debt held internationally, absorbing it may hinge more on yield, currency and ratings considerations than in Japan.
The hard work on UK debt reduction may await whoever’s in power after the next general election, probably in 2024. Hunt was doubtless reluctant to tighten the fiscal screw faster given the prospect of further monetary tightening, however slight, and the spectre of recession. This is just as well if Sunak expects economic recovery before then.
Neil Williams is Chief Economist at OMFIF.
These themes will be explored further in OMFIF’s Global Public Investor 2023, publishing in June.