A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’.

Last week’s UK Autumn Statement involves a major tightening of fiscal policy, similar to the consolidation launched by a previous Conservative chancellor, George Osborne, in 2010. Whereas the 2010 tightening was launched into an economy that was growing, today’s tightening will hit an economy that is in recession.

The UK has seen a remarkable U-turn on fiscal policy in the last two months. On 23 September, the previous chancellor, Kwasi Kwarteng, announced the largest tax cuts in 50 years and a major easing of fiscal policy. Those cuts were first reversed and now, under a new chancellor, Jeremy Hunt, fiscal policy is being tightened.

After the financial market turmoil unleashed by the mini-budget, Hunt’s Autumn Statement signals a return to fiscal orthodoxy. But an era of low interest rates, and cheap borrowing costs for government, is over. Interest costs have risen sharply this year and the Office for Budget Responsibility (OBR) expects government debt interest payments to rise above spending on any public service except the NHS by 2027-28. Governments, in the UK and elsewhere, need to find more money to pay interest costs. The fate of the UK mini-budget shows governments also need to maintain the confidence of financial markets.   

While Osborne’s deficit reduction programme was focussed on cutting public spending, Hunt expects tax rises to do more of the heavy lifting. Under his plans, the tax take is forecast to rise to its highest level since the second world war. The greater reliance on tax rises partly reflects a view that, with public services under pressure and the economy in recession, there is less room to cut spending. Nonetheless, more than half of this retrenchment is to come in the form of spending cuts.

Given the cost-of-living crisis and an economy in recession, the chancellor has pushed most of the pain of spending cuts into the future. A cynic might note that some of the most politically difficult reductions have been delayed until after the next general election.

Hunt has also had to ease the rules governing fiscal policy. As has happened previously in the recent past, a chancellor, faced with a slowdown and rising borrowing, has shifted the goalposts. Hunt has scrapped the previous rule that required the elimination of borrowing for current spending and extended the time to get government debt on a downward trajectory.

Even with a less demanding fiscal target the government faces an uphill task of reducing debt in the current environment. The OBR says that the UK economy is in recession and that GDP will not return to its pre-pandemic peak until 2025. The OBR believes that UK households will endure two consecutive years of the sharpest contractions in disposable income on record. Hunt’s plans to right the UK public finances could easily be blown off course by more persistent inflation or a deeper downturn than expected by the OBR.

Osborne’s austerity drive shows how difficult it is to reduce government debt even when the economy is growing. By 2015, Osborne had achieved only half the consolidation he had aimed for in his June 2010 budget. The success of this Autumn Statement, like its predecessors, will not be judged by the government’s ability to deliver it to the letter. It will be judged more on its ability to deliver a credible reduction in debt over time.

For all the talk of austerity, the UK public sector is, with the exception of the pandemic, larger today as a share of GDP than at any time since 1975. Nor, despite sharply rising levels of public borrowing, have taxpayers got off lightly. Taxes now account for a larger share of GDP than at any time since 1950. Whichever party wins the next election will face a daunting combination of a large, but still-stretched public sector, high levels of taxation and elevated public debt.

PS: The OBR is rather more optimistic on UK house prices than we are. It forecasts a 9% drop in prices against our forecasts for a decline of 15%.

PPS: My colleague Edoardo Palombo last week updated our Financial Stress Index. The index has risen sharply driven by sharply higher gilt yields and market expectations for interest rates in the wake of the mini-budget. The index is now at the highest levels since 2010 testifying to a significant tightening of financial conditions.

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