UK Government Borrowing Undershoots, But Tax Cuts Still Unlikely

UK government borrowing came in below official forecasts in the first five months of the fiscal year, but a challenging economic outlook means Chancellor Jeremy Hunt may have only limited room to cut taxes before a general election.

(Bloomberg) — UK government borrowing came in below official forecasts in the first five months of the fiscal year, but a challenging economic outlook means Chancellor Jeremy Hunt may have only limited room to cut taxes before a general election.

The budget deficit between April and August was £69.6 billion ($85.7 billion), the Office for National Statistics said Thursday. That’s £11.4 billion less than the Office for Budget Responsibility forecast in March.

The deficit in August alone was £11.6 billion, close to the £11.1 billion median forecast in a Bloomberg survey and up from £8.1 billion a year earlier. Government debt stood at 98.8% of GDP, a level last seen in the early 1960s. The monthly deficit was the fourth-highest for an August since records began in 1993.

Borrowing between April and July was revised up by £1.5 billion, largely because tax receipts were higher than previously thought.

The strength of tax revenue is fueling calls from ruling Conservative Party lawmakers who say Prime Minister Rishi Sunak’s administration is facing electoral defeat unless the Treasury cuts taxes to ease the cost-of-living crisis for ordinary voters. 

However, Hunt has all but ruled out tax cuts in his autumn economic statement in November, saying his priority is bringing down inflation, and signaled that any reductions in the spring budget will be financed by further spending restraint. 

“These numbers show why after helping families in the pandemic we now need to balance the books,” Hunt said in a statement. “That becomes much easier when inflation is under control because higher inflation pushes up interest rates, so we need to stick to the plan to get it down.”

The reason is that high interest rates and the possibility of a recession make it harder for the chancellor to meet his self-imposed rules, which require 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. However, market assumptions that interest rates will be higher than the OBR forecast in March mean Hunt may no longer have any headroom at all. 

“Households usually enjoy tax cuts in the run-ins to general elections, but we expect Mr. Hunt to make only token gestures in the Autumn Statement,” said Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

In August 2023, the interest payable on central government debt was £5.6 billion, £3.1 billion less than in August 2022, and £2.2 billion below the OBR’s forecast of £7.8 billion.

Welfare costs continued to climb, however. Benefits cost increased by £2.7 billion compared with August last year following the 10.1% inflation-linked uprating in 2023. The government has unveiled plans to clamp down on escalating working age welfare costs and is looking into the triple lock on state pensions. 

Pay Settlements

For the year to date, benefit payments are up £13.9 billion the ONS said. Staff costs are also rising following a series of public sector pay settlements. Compared with last year, they are £9.4 billion higher.

“Longer-term headwinds remain, leaving uncertainty around the fiscal outlook beyond the next election,” said Michal Stelmach, senior economist at KPMG UK. “That will leave the government facing a trade-off between higher taxes or lower spending, neither being a popular option.”

Fitch’s shock decision the strip the US government of its AAA status has reignited questions about the UK’s credit rating. 

Taxes this year are being boosted by healthy wage growth and higher prices, which is generating more income tax, value-added tax and corporation tax for the Treasury. That’s offset the cost of debt payments and public-sector pay, where labor disputes have forced the government to increases pay and bonuses. 

Markets believe the Bank of England is close to ending its interest rate rise cycle, which would take some upward pressure off the public finances, which have been crippled by debt servicing costs. It may hold rates Thursday, ending a streak of 14 successive hikes.

“If we are right in expecting the economy to weaken later this year, tax receipts will probably soon disappoint,” said Ashley Webb at Capital Economics. Hunt, he said, “will probably have some wiggle room for tax cuts and/or spending rises in the Budget in March 2024. That would give the Bank of England another reason to keep interest rates at their peak for longer than the Fed and the ECB.”

Debt costs are expected to exert less of a drag on the public finances as inflation slows, as payments on a quarter of all government bonds are pegged to the retail prices index. 

However, controlling the welfare bill remains a challenge, with retirees in line for another bumper increase to the state pension next year and the number of sick working age benefit claimants rising. Earlier this month, the government announced plans to tighten conditions for people claiming health-care benefits amid warnings that the health crisis gripping the UK is costing the state more than £15 billion a year in higher benefits and lost tax income.  

–With assistance from Eamon Akil Farhat.

(Updates with BOE expectations. An earlier version corrected third paragraph to show budget deficit was up from a year ago.)

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