The UK government is ushering in a new era of austerity to restore market confidence

Chancellor of the Exchequer Jeremy Hunt arrives at the back entrance of Downing Street, London.

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LONDON — Britain’s new Chancellor of the Exchequer Jeremy Hunt must weigh the country’s economic danger against his party’s political survival on Thursday as he makes a long-awaited fiscal statement.

Hunt is expected to announce tax increases and spending cuts totaling between £50bn ($58.85bn) and £60bn a year as he seeks to plug a significant gap in the country’s public finances as he markets the post-war crisis. chaos of its fiscal credibility unleashed by former Prime Minister Liz Truss’ disastrous “mini-budget” in late September.

The Bank of England has predicted that the UK is about to enter its longest recession on record, and the Office for National Statistics confirmed on Friday that GDP contracted by 0.2% in the third quarter of 2022.

The Bank is also seeking to bring inflation back to its target from a 40-year high of 10.1% in September, and earlier this month imposed its biggest rate hike since 1989.

“We will see everyone pay more tax. We will see cuts,” Hunt told the BBC on Sunday, while also promising that after April the government would come up with a new and more targeted plan to help with household energy bills .

Reports have suggested that many of the most radical austerity measures introduced by Prime Minister Rishi Sunak’s new government will come into effect from 2025, after the next general election.

British Chancellor of the Exchequer Hunt faces a difficult choice between economics and politics: JPMorgan's Gimber

“The government and the Bank of England are in a very difficult position because the chancellor’s choice next week isn’t so much about what’s going to happen – he’s already told the market that the debt forecast over the next few years – it’s rather the timing,” Hugh Gimber, global markets strategist at JPMorgan Asset Management, told CNBC on Friday.

He added that Hunt faces an important decision between bringing forward the pain that Sunak’s government has promised to rebalance the economy and delaying the major impact of the new measures to avoid further political damage, at the risk of prolonging the crisis.

“At the moment you can make a strong case economically saying bring it forward, bring it forward, reduce the amount the Bank of England has to do to slow the economy, but politically there is clearly a difficult challenge ahead.” there,” Gimber said.

In most election polls in recent weeks, the main opposition Labor Party has a lead of about 20 points over Sunak’s ruling Conservatives, indicating that the damage suffered from Truss’s 45-day tenure and the series of scandals her predecessor Boris Johnson plagued, has not been resolved. settled by Sunak’s promise of a return to fiscal credibility.

Budget cuts versus tax increases

Thursday’s statement will be accompanied by a long-awaited set of projections from Britain’s independent Office for Budget Responsibility (OBR), and following the Bank of England’s bleak outlook a few weeks ago, economists expect a similarly bleak picture to emerge.

In a note Monday, German Bank said the OBR is likely to predict a “deep and protracted recession” in 2023, with growth expected to remain subdued until 2025 at the earliest and inflation forecasts to rise significantly due to more sustained price increases.

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

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“Taken together, the challenging economic outlook is likely to underscore the main reason for the size of the fiscal gap, with our 2026/2027 credit projections projecting slightly above GBP 90 billion (OBR Spring Statement. GBP 32 billion),” said Deutsche. Bank Chief UK. Economist Sanjay Raja said.

Raja expects cuts and tax increases in Hunt’s plans to be split 60:40, though he said these would be done “stealth”, with tax increases focusing on freezing personal allowances and tax brackets, while the threshold for the additional tax rate will be reduced from £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. Firstly, an increase in the council tax with local authorities made it possible to raise the council tax level above 3% without a referendum,” said Raja.

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

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In all, Deutsche expects the “fiscal drag” of hidden taxes and higher windfall taxes to net the Treasury about £35bn given high inflation and energy prices.

Cutbacks, again carried out via “stealth,” could take the form of “nominal cash freezes on departmental budgets,” Raja said, with spending budgets minimally replenished in the future.

“Capex plans are also likely to be cut in coming years, and ‘efficiency cuts’ are likely to be part of the chancellor’s plans to close the fiscal gap,” Raja said.

“This will help offset some of the expected spending increases as Social Security and pension benefits are now likely to be supplemented by inflation rather than earnings growth.”

Market waits with bated breath

The market flatly rejected September’s fiscal announcements from former Finance Minister Kwasi Kwarteng sterling 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 reassure the markets, he will have to announce early action in the form of major fiscal tightening, which could deepen and/or prolong the recession and ultimately create an even bigger fiscal gap,” said Ruth Gregory, senior UK economist at Capital Economics.

“If he tries to minimize the economic pain, he risks upsetting the markets and triggering another rise in government bonds, which would also worsen public finances.”

Capital Economics expects Hunt to unveil fiscal tightening measures to the tune of £54bn, about 1.9% of GDP, but that this will be funded primarily by nuanced tax increases rather than austerity, with most policy measures “later in place” starting earlier”. said Gregory.

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