UK government to usher in new era of austerity to restore market confidence

UK government to usher in new era of austerity to restore market confidence
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Chancellor of the Exchequer Jeremy Hunt arrives at the back entrance of Downing Street, London.

Aaron Chown – Pa Pictures | So pictures | Getty Images

LONDON – Britain’s new Treasury Secretary Jeremy Hunt must weigh the country’s economic danger against his party’s political survival on Thursday when he makes a long-awaited financial statement.

Hunt is expected to announce tax hikes and spending cuts totaling between £50bn ($58.85bn) and £60bn a year as he seeks to plug a significant hole in the country’s public finances close and at the same time convince the market Fiscal credibility after the chaos unleashed by Former Prime Minister Liz Truss’ disastrous ‘mini-budget’ End of September.

That Bank of England has projected that the Britain is at the start of its longest recession on recordand the Office for National Statistics on Friday confirmed that GDP contracted by 0.2% in the third quarter of 2022.

The bank is also trying to push inflation back on target 40-year high of 10.1% in Septemberand earlier this month imposed the biggest rate hike since 1989.

“We will see that everyone pays more taxes. We will see spending cuts,” Hunt told the BBC on Sunday, while pledging the government would come up with a new and more targeted plan to support household energy bills beyond April.

Many of the most radical austerity measures envisaged by new Prime Minister Rishi Sunak’s government are reported to come into effect from 2025 after the next general election.

UK Treasury Secretary Hunt faces a difficult call between business and politics: JPMorgan's Gimber

“The Government and Bank of England are in a very difficult position because next week’s election of the Chancellor doesn’t matter so much what happens – he has already told the market the debt forecast needs to be revised down in the next few years — it’s more the timing,” Hugh Gimber, global markets strategist at JPMorgan Asset Management, told CNBC on Friday.

He added Hunt faces an important choice between bringing forward the pain Sunak’s government has promised to bring the economy back into balance and delaying the big impact of the new measures to prevent further political damage on the hazard a prolongation of the crisis.

“Right now you can be economically persuasive to say it’s preferable to reduce the amount the Bank of England has to do to try and slow the economy, but politically there’s clearly a difficult challenge there,” said Gimber.

Most election polls in recent weeks give the main opposition Labor Party a lead of around 20 points over Sunak’s ruling Conservatives, indicating the damage has been sustained under Truss’s 45-day tenure and string of elections Scandals that plagued her predecessor Boris Johnsonwas not invalidated by Sunak’s promise of a return to fiscal credibility.

Spending cuts vs. tax increases

Thursday’s statement comes with long-awaited forecasts from the UK’s independent Office for Budget Responsibility (OBR), and after the Bank of England’s bleak outlook a few weeks ago, economists are expecting a similarly bleak picture.

In a note Monday, Deutsche Bank said the OBR is likely to forecast a “deep and protracted recession” in 2023, with growth remaining subdued until 2025 at the earliest and inflation forecasts rising significantly to reflect more sustained price increases.

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

The UK financial event will show that

“All in all, the challenging economic outlook is likely to underscore the main reason for the size of the fiscal hole given our 2026/27 borrowing forecasts for just over 90bn, said economist Sanjay Raja.

Raja expects spending cuts and tax increases in Hunt’s plans to be split 60/40, but said it would be done “on the sly”, with tax increases focused on freezing personal allowances and tax bands, while also lowering the threshold for the an additional tax rate of £150,000 to £125,000 to generate more revenue for the Treasury.

“Apart from ‘Stealth Taxes’, we expect a few more options to be announced
Thursday. First, an increase in council tax by local authorities made it possible to increase council tax to over 3% without a referendum,” Raja said.

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

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Overall, Deutsche predicts the “fiscal burden” of camouflage taxes and higher windfall taxes will net the Treasury around £35billion amid high inflation and energy prices.

Spending cuts, again implemented “on the sly,” could take the form of “nominal cash freezes in departmental budgets,” Raja said, with minimal increases in future spending budgets.

“Investment plans are also likely to be cut in the coming years, and ‘efficiency savings’ will likely be part of the chancellor’s plans to close the budget gap,” Raja said.

“This will help offset some of the expected increases in spending as welfare and pension payments are now likely to be boosted by inflation rather than income growth.”

The market waits with bated breath

The market flatly dismissed former Finance Minister Kwasi Kwarteng’s September tax announcements sterling slipped to an all-time low and government bond yields rose so fast that the Bank of England was forced to step in and prevent the collapse of pension funds.

“If he wants to calm the markets, he needs to announce early action in the form of a major fiscal tightening. That could deepen and/or prolong the recession and ultimately create an even bigger fiscal hole,” said Ruth Gregory, Senior UK Economist at Capital Economics.

“If it tries to minimize economic pain, it risks unsettling markets and triggering a further rise in gilt yields, which would also worsen public finances.”

Capital Economics expects Hunt to announce £54bn of fiscal tightening, around 1.9% of GDP, but it will be funded primarily by nuanced tax hikes rather than spending cuts, with most policies “rather start later than earlier”. said Gregory.

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