The British government will usher in a new era of austerity to restore market confidence

LONDON — Britain’s new finance minister, Jeremy Hunt, is set to weigh the country’s economic peril against his party’s political survival on Thursday as he delivers a long-awaited budget statement.

Hunt is expected to announce tax hikes and spending cuts totaling between £50billion ($58.85billion) and £60billion a year as he tries to plug a substantial hole in public finances of the country, while reassuring the market of its fiscal credibility after the chaos. triggered at the end of September by the disastrous “mini-budget” of former Prime Minister Liz Truss.

The Bank of England has forecast that the UK is at the start of its longest recession on record, and the Office for National Statistics confirmed on Friday that GDP contracted by 0.2% in the third quarter of 2022.

The Bank is also trying to bring inflation back to its target since the 40-year high of 10.1% seen in September, and earlier this month imposed its biggest interest rate hike since 1989.

“We’re going to see everyone paying more tax. We’re going to see spending cuts,” Hunt told the BBC on Sunday, while promising the government would come up with a new, more targeted plan to help people’s energy bills. households beyond April.

Reports suggest that many of the most sweeping austerity measures planned by the government of new Prime Minister Rishi Sunak will take effect from 2025, after the next general election.

“The Government and the Bank of England are in a very difficult position because the Chancellor’s choice next week is not so much about what is going to happen – he has already told the market that the debt forecast must come down to the over the next few years – now is the time,” Hugh Gimber, global market strategist at JPMorgan Asset Management, told CNBC on Friday.

He added that Hunt faces a key decision between anticipating the pain that Sunak’s government has promised to rebalance the economy and delaying the major impact of new measures to avoid further political damage, at the risk of prolonging the crisis.

“At the moment you can make a strong case economically to say that it is anticipated, advanced, reduced the amount the Bank of England has to do to try to slow the economy, but politically there is clearly a tough challenge there,” Gimber said.

Most election polls in recent weeks give the main opposition Labor party a lead of around 20 points over Sunak’s ruling Tories, indicating that the damage suffered under Truss’s 45-day tenure and series of scandals that plagued his predecessor Boris Johnson have not been undone by Sunak’s promise of a return to fiscal credibility.

Spending cuts vs tax hikes

Thursday’s statement will be accompanied by a series of long-awaited projections from the UK’s Independent Office for Budget Responsibility (OBR), and following the dismal outlook from the Bank of England a few weeks ago, economists expect until an equally bleak picture emerges.

In a note on Monday, German Bank said the OBR is likely forecasting a “deep and prolonged recession” in 2023, with growth remaining subdued through 2025 at the earliest and inflation projections rising significantly to reflect more persistent price increases.

Deutsche also expects the OBR to forecast a slow recovery in the country’s tight labor market, with unemployment reaching around 5.5-6% over the next two to three years.

“Overall, the challenging economic outlook will likely highlight the main reason for the size of the fiscal hole, with our borrowing projections just over £90bn in 2026/27 (OBR Spring Statement. GBP 32bn) “said the head of Deutsche Bank in the United Kingdom. said economist Sanjay Raja.

Raja expects spending cuts and tax hikes to be split 60:40 in Hunt’s plans, although she said it would be done in a ‘stealth’ way, the tax hikes being focused on freezing personal allowances and tax brackets, while reducing the additional tax rate threshold by £150,000. to £125,000 to generate more revenue for the Treasury.

“Away from ‘stealth taxes’, we expect to see a few more options advertised on
Thursday. Firstly, an increase in housing tax with local authorities has allowed the level of housing tax to be raised above 3% without a referendum,” Raja said.

“And second, an increase in both the duration and magnitude of the windfall tax on oil and gas ‘excess profits’.”

In total, Deutsche predicts that the “tax brake” of stealth taxes and windfall taxes will net the Treasury around £35bn given high inflation and energy prices.

The spending cuts, again executed in a “stealth” manner, could take the form of “nominal cash freezes of departmental budgets”, Raja said, with spending budgets increased to a minimum in the future.

“Investment plans are also likely to be scaled back over the next few years, and ‘efficiency savings’ are likely to feature as part of the Chancellor’s plans to close the fiscal hole,” Raja said.

“This will help offset some of the expected spending increases, with social benefits and pensions now likely to be supplemented by inflation rather than income growth.”

The market is eagerly awaiting

The market flatly rejected former finance minister Kwasi Kwarteng’s September tax cut announcements, with sterling slipping to historic lows and government bond yields climbing so rapidly that the Bank of England was forced to step in and prevent the collapse of pension funds.

“If he wants to reassure the markets, he will have to announce quick action in the form of a big fiscal tightening. This could deepen and/or lengthen the recession and ultimately create an even bigger fiscal hole,” said Ruth Gregory, senior UK economist at Capital Economics.

“If he tries to play down the economic pain, he risks destabilizing markets and causing gilt yields to spike again, which would also deteriorate public finances.”

Capital Economics expects Hunt to reveal fiscal tightening measures to the tune of £54bn, around 1.9% of GDP, but that this will be funded mainly by nuanced tax hikes rather than spending cuts, with most policies ‘starting later than sooner’. said Gregory.