Rishi Sunak delays UK fiscal squeeze until year before next election
Rishi Sunak put off steps to tackle the UK’s record budget deficit for another two years, focusing on stimulus for a recovery from the coronavirus pandemic.
Tax and spending measures in the chancellor of the exchequer’s annual budget will add 73 billion pounds ($101 billion) to the economy by April 2023. In the three years after that, the Treasury will take back almost the same amount of money and drive the overall tax burden to its highest since the 1960s.
It’s a political gamble for Sunak since the Conservative government will be campaigning for re-election in 2024 around the time when the tightening starts to bite. That would also be around the time that some economists expect the Bank of England to start unwinding its own stimulus after cutting interest rates to a record low and expanding its asset purchase program.
“The debate will become at what point the bank will want to give some sort of hawkish signal about starting the process of normalization,” Jacob Nell, chief U.K. economist at Morgan Stanley and a former Treasury official, said in an interview after Sunak’s statement on Wednesday. “Previously we had the recovery lagging. Now it’s going to be level-pegging with Europe.”
Sunak’s largesses brings to about 350 billion pounds the sum the Treasury is spending on the Covid crisis. With Prime Minister Boris Johnson’s rapid vaccination program opening the prospect of fewer restrictions by the middle of this year, Sunak is allowing time for a recovery to gather momentum before fixing the public finances.
The looser fiscal stance added fuel to a rise in interest rates in financial markets, where investors increasingly anticipate both a quick bounce for the economy and higher borrowing. U.K. government bonds led a sell off across Europe on Wednesday, with yields on the benchmark 10-year gilt rising 9.3 basis points.
What Our Economists Say ...
“With Sunak giving the economy more chance to recover before removing the key pillar of fiscal support, the chances of a sharp rise in unemployment when the scheme ends have been dramatically reduced. By limiting the rise in unemployment Sunak has raised the possibility of the economy recovering more quickly.”
--Dan Hanson, Bloomberg Economics.
“The fiscal backdrop will be more favorable for growth this year and next,” said Allan Monks, an economist at JP Morgan Securities Plc. “We also think this has some implications for the BOE. This hints at an earlier start to monetary policy tightening.”
The economy will return to its pre-pandemic level by the middle of next year, six months earlier than forecast in November, according to the Office for Budget Responsibility. The agency said Sunak’s decision to extend wage support for furloughed workers means unemployment is likely to peak at 6.5% rather than 7.5% -- a difference of about 340,000 people.
Business investment, which stagnated following the 2016 Brexit referendum and plunged last year, is set to get a boost from Sunak’s announcement of a 12 billion-pound temporary tax break that encourages firms to bring forward investment from future years. The OBR sees investment jumping by almost 17% in 2022.
The scale of those measures plans prompted some economists to lift their forecasts for growth. Others said it complicated the task facing the central bank.
“This is tricky for the BOE because at the two-year horizon, where monetary policy has most effect, you’re going to see a large fiscal contraction,” said Robert Wood, chief U.K. economist at Bank of America. “You can’t have both the BOE hiking rates and the government consolidating to this degree at the same time.”
Sunak plans to raise taxes from 2023 by lifting the main rate on corporate profits, freezing tax thresholds and reducing existing departmental spending plans by about 4 billion pounds a year. The chancellor said his aim is for Britain only to borrow for investment, not day-to-day spending, a goal the OBR said he may come close to meeting by the middle of the decade.
Despite the brighter near-term outlook, the OBR was no more optimistic that the economy will escape the scarring effects of the pandemic. Five years from now, it said GDP may be 3% lower than it would have been had the crisis not happened.
Some of the Treasury’s forecasts could be difficult to achieve. The government sees income from property-transaction taxes soaring 40% to 17.3 billion pounds in 2025-26 from 12.3 billion pounds in the coming fiscal year. That’s almost as much as was raised before the pandemic and without a tax holiday on purchases.
“More may yet need to be done in forthcoming fiscal events in order toput the public finances back on an even keel,” said George Buckley, chief U.K. economist at Nomura International Plc in London.
Even so, the macroeconomic outlook delivered by the Treasury is similar to the Bank of England’s expectation of a sharp rebound starting the the middle of the year.
“The budget delivered a net, near-term fiscal loosening, which should buttress the economic recovery,” said Martin Beck at Oxford Economics. “The OBR’s forecast of 4% GDP growth this year looks far too pessimistic -- we are considering raising our current projection of 5.5%.”