Prime Minister Liz Truss promised growth and tax cuts, but the risks of recession are mounting for the UK after her economic package backfired and forced the Treasury to raise taxes and weigh deep spending cuts.
The measures set out by Chancellor of the Exchequer Jeremy Hunt on Monday will pare £32 billion ($51.53 billion) from the £45 billion of tax giveaways Truss’s government announced last month in a mini-budget that triggered a sharp sell-off in UK assets.
Support for energy bills will also be curtailed from April, causing fresh hardship for households and businesses that are already struggling with rising prices and interest rates.
The decision marks a massive U-Turn, with Hunt ripping up Truss’s “Growth Plan” in a desperate attempt to avert an economic calamity and salvage the government’s standing.
Britain will be paying the price of Truss’s economic experiment for some time. Lost credibility shows up as a penalty on borrowing costs that Dario Perkins, director of macro global at TS Lombard, calls the “moron risk premium.”
See also: ECB delivers landmark rate cut but few signals top
Jamie Rush, chief European economist at Bloomberg Economics, estimates the penalty that has emerged since early September at a bit more than £10 billion a year by 2025.
Sterling collapsed to a record low and government bond yields soared on fears that the debt-funded giveaways would send the national debt spiralling higher. That threatened to plunge the UK into “a severe downturn driven by a continued loss of market confidence,” said Martin Beck, chief economic adviser to the EY Item Club.
See also: ECB holds rates and signals cuts are still some way off
While Hunt’s emergency response may avoid the worst-case scenario, the economy will “still decline over the next few quarters,” Beck added. Bloomberg Economics reckons the risks to its forecast for a 0.4% drop in GDP in 2023 have “shifted to the downside.”
In an attempt to restore confidence, Hunt unveiled a new team of independent economists stuffed with market experts including BlackRock Inc.’s Rupert Harrison, who advised then-chancellor George Osborne during the austerity years from 2010 to 2015.
Hunt also warned that spending cuts will be needed in the weeks ahead, signalling that a budget statement due Oct 31 will outline some of the more painful reductions. The Labour opposition said it amounted to “Austerity 2.0.”
The policy switch means the Treasury will no longer be working against the Bank of England by adding to inflationary pressures. Hunt wants to shore up investor confidence and put the public finances on a stable footing -- demoting Truss’s growth agenda.
Addressing parliament, Hunt hinted at new fiscal rules that will ensure debt is falling as a share of national income and that, once the public finances are under control, there will be no borrowing to fund day-to-day spending.
The potential framework helps explain his warning that “very difficult decisions on tax and spending” still need to be made. He did not rule out a windfall tax, in stark contrast to firm pledges last month by Truss, or scrapping big infrastructure projects like the HS2 rail upgrade.
To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section
On public spending, he rejected comparisons with austerity when Osborne was chancellor. However, he would only commit to increasing spending in cash terms, which implies big cuts once inflation is factored in, and said his preference would not be to cut capital spending as that would clash with plans for growth.
Hunt needs to find at least another £13 billion more savings to stabilize the public finances, according to Hanson.
The outlook for the UK economy has been deteriorating for weeks, with inflation near its highest in 40 years sapping confidence and forcing consumers to tighten their belts. Goldman Sachs Group Inc. slashed its forecasts over the weekend, and a survey of economists by Bloomberg anticipates a recession starting this year followed by zero growth until late 2023.
Business groups welcomed the attempt to calm markets but warned that the UK is now economically rudderless, with no long-term plan and a tax burden stuck at the highest in 70 years.
British Chambers of Commerce director general Shevaun Haviland warned it’s “a plan for today, and nothing for tomorrow.” She’s concerned about the double impact of a surge in energy bills due to hit at about the same time that corporation tax will increase to 25% from 19%.
“This will be a hammer blow for many who were already worried about how they will survive,” Haviland said.
Many households will pay higher electricity and natural gas bills starting in April after Hunt said aid should be more carefully targeted.
The government will maintain its freeze on energy bills at £2,500 through this winter as it reviews a new mechanism that will protect the public purse from volatility in global gas markets but will be adjusted from April.
That means companies and households will “pick up more of the tab,” according to Capital Economics. The uncertainty about how much it will cost may mean “inflation ends up being higher for longer next year and that the recession is deeper as a result.”
Energy bills are now on track to rise to £4,000 next Spring, according to Resolution Foundation
Pressure is easing on the Bank of England to hike interest rates. While Truss’s previous budget would have added to inflation, the impact of Hunt’s decisions will be much more restrained.
Investors are now betting the BOE’s key rate will peak at 5.25%, a full percentage point lower than fears in the middle of last month. Inflation at almost 10% is still five times higher than the BOE’s 2% target, but the Treasury’s lack of largess is helpful to efforts to rein in prices.
“The implication for the Bank of England is that with a tougher fiscal stance monetary policy action can afford to be less aggressive,” George Buckley, an economist at Nomura Holdings Inc., wrote in a note to clients.
Falling interest rates in financial markets also offered some respite. Ten-year government borrowing costs have dropped a half percentage point since the peak of the crisis, easing upward pressure on the cost of mortgages, and short-term rates have fallen a whole point.
Office for Budget Responsibility data suggests that may reduce the Treasury’s annual debt interest bill by about £12 billion, an early win from Hunt’s emergency plan that will take some pressure off the public finances.
