Hunt’s Fiscal Headroom Disappears With High UK Interest Rates

UK Chancellor Jeremy Hunt has little scope for giveaways in his Autumn economic statement, which he announced on Tuesday would be held on Nov. 22, as higher interest rates wipe out his fiscal headroom.

(Bloomberg) — UK Chancellor Jeremy Hunt has little scope for giveaways in his Autumn economic statement, which he announced on Tuesday would be held on Nov. 22, as higher interest rates wipe out his fiscal headroom.

Hunt is bound by self-imposed rules requiring government debt to be falling as a share of GDP in five years. In March, the Treasury was judged to have a margin of just £6.5 billion ($8.2 billion), the smallest on record, and economists expect things to remain tight as the target date rolls forward a year to 2028-29.

It will leave Hunt under mounting pressure from fellow Conservatives who say the party is doomed at a general election expected next year unless the government cuts taxes. Any tax breaks are likely to be reserved for the budget in the spring and offset by further spending restraint.

The Treasury declined to comment when asked about the Autumn Statement. 

The fiscal constraints typically loosen when the Office for Budget Responsibility forecasts roll forward in the autumn by buying the chancellor an extra 12 months. However, this time a number of factors are working against him.

First, market assumptions for interest rates are roughly a percentage point higher than at the time of the March budget, when the fiscal watchdog last updated its outlook. Andrew Goodwin, chief UK economist at Oxford Economics, estimates the impact in the critical fifth year of the forecast will be to add about £15 billion to debt-servicing costs.

Second, the extra year pushes the OBR forecast beyond the policy horizon. Currently, the biggest revenue-raising measure is a freeze on income-tax thresholds. The policy is due to last until 2027-28, at which point the OBR will revert to its standard assumption that thresholds rise in line with inflation.

Third, the tight spending plans for government departments – of just 1% growth a year in real terms – also end in 2027-28 after which they revert to the OBR’s more generous assumption that they rise in line with nominal GDP.

Fourth, the OBR revealed in a paper last month that it “has tended to overestimate real GDP growth and underestimate government borrowing over the medium term.” Its current estimate of the sustainable growth rate is already more optimistic than most external forecasters. Another boost to growth forecasts is unlikely, and the OBR may even revise them down to align better with others.

Fifth, the UK may be a less tax rich economy than it seemed. Since the pandemic, tax receipts appeared to have been stronger than expected for a given amount of output. However, statistical revisions last week showed that the size of the economy had been underestimated.

On top of those headwinds, departments may need extra money in the long term to cover higher costs due to larger-than-expected public-sector pay settlements. 

Government borrowing since the fiscal year began in April has come in below OBR forecasts, raising hopes that the chancellor will have a windfall to spend, but the boost has largely been down to better-than-expected growth this year. The more important longer-term forecasts may be less rosy.

Speaking at the weekend, Hunt played down the prospect of tax cuts in the Autumn Statement, saying he wanted to avoid “easy decisions” and instead take ones that are “right for the long term.” His priority is delivering on a pledge to halve the rate of inflation this year.

The government is already looking for savings. On Tuesday, Work and Pensions Secretary Mel Stride announced welfare changes that would make it harder for working-age Britons with “limited capability” for work to get disability benefits.

The policy is an attempt to cap the spiraling cost of health-related benefits. The OBR estimates the number of claimants will rise by 500,000 in the next four years, adding £3.4 billion to the annual welfare bill.

But the Bank of England, which is expected to raise rates another quarter point to 5.5% this month, could yet play a critical role by shaping market expectations for interest rates until 2028. 

“The government needs those interest rates to come down,” Goodwin said. “They have two months for market rates to turn. Until they come down, it will be hard for the chancellor to do much.”

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