England’s Chancellor of the Exchequer John Healey had two main aims in releasing the autumn budget on Thursday: to support households and businesses through the latest energy shock and to convince financial markets that he is fiscally responsible.
He appears to have achieved both. The yield on 10-year gilts fell slightly, indicating that financial markets were unfazed, despite the government pledging to spend around £4 billion to support the economy through the winter.
But he achieved this by postponing most of the major, and more difficult, decisions until next year. That sets up next year’s budget and spending review to be much bigger and tougher affairs than today’s event. Brace yourselves for higher taxes further down the line.
Budget passes sniff test
Despite the reduction in fiscal headroom from £23.6 billion in March to £15 billion now, the gilt market’s muted reaction suggests that Healey’s first budget has passed the financial markets’ sniff test.
But this slim margin leaves the public finances vulnerable to further adverse moves in interest rates or inflation. The OBR estimates that headroom would need to be £50 billion to give the government a 70% chance of meeting its fiscal rule.
OBR forecasts look pessimistic
The major policy announcements focused on supporting households through the energy crisis this winter. The removal of standing charges from utility bills, the freeze in fuel duty and the three-month delay from April to the reversal of VAT cuts on electricity were complemented by a £100 energy bill rebate for households in lower-valued council tax bands.
Together, these measures will cost around £4 billion and shave about 0.1 percentage points off inflation next year. They will be paid for through a temporary 0.3 percentage point increase in the Bank Surcharge rate to 6% for 15 months, higher gambling taxes and a smorgasbord of smaller tax rises.
At the same time, the OBR raised its growth forecast for this year slightly, to 1.2%, but cut its forecast for GDP growth in 2027-28 by 0.5 percentage points to 1.1%, owing to higher interest rates and inflation.
But both forecasts look pessimistic to us. The UK economy has already grown by 1.3% in the first eight months of the year, while surveys suggest that the third quarter will also be strong. Unless activity collapses in the fourth quarter, growth should significantly exceed the forecast. Growth will slow next year as higher inflation and interest rates take their toll, but we still expect it to remain well above 1%.
Interest rate hikes still on track
Given the relatively minor changes to tax and spending policy, the budget will make little difference to the Monetary Policy Committee’s decision next week. Indeed, with growth stronger than expected, the labour market improving and inflation likely to rise above 4.5%, a rate rise next week looks almost guaranteed.
The Bank of England is likely to follow this with at least one further rate rise next year, probably in February. The announcements in today’s budget will trim inflation slightly, but not by enough to change that outlook.
The much bigger issue for the MPC is what happens to energy prices over the winter. A further rise in natural gas prices would probably cement the case for a third increase, while a fall would point to a prolonged pause after February.
UK public finances remain unstable
Looking at the public finances in detail, we think the autumn budget is far less credible than the headlines suggest. There are several reasons for this.
First, the largest tax-raising measure is the effort to close the tax gap. This is notoriously difficult to achieve in practice and creates a significant risk that receipts will undershoot in future.
Moreover, the focus on a smorgasbord of smaller taxes—the budget contained 98 individual measures, the most since 2010, is likely to create distortions. Some measures also have highly uncertain behavioural effects and revenue yields, increasing the chances that tax receipts disappoint.
Second, there was little in the budget to put the public finances on a more sustainable long-term footing. There are now even more fiscal fictions such as the plan to raise fuel duty. Moreover, the current plans envisage real-terms spending cuts that this government will find almost impossible to deliver.
Add to this the pressure to increase defense spending, and the inevitable conclusion is that either taxes will have to rise further over the next few years—which will be difficult under the current manifesto commitments—or the government will have to bear down harder on welfare spending. This conundrum increases the chances of an early general election.
Third, the budget contained no new measures aimed at boosting the UK’s long-term growth rate, despite the rhetoric. Although an additional £20 billion was allocated to public financial institutions, there was no indication of how this would lift growth.
The takeaway
Overall, today’s budget cleared the relatively low bar of not upsetting bond markets, while offering households and businesses some support with energy bills. But the slim margin of fiscal headroom leaves the UK vulnerable to any further deterioration in market conditions or the geopolitical backdrop.
Moreover, there seems little chance that the government will deliver its planned fiscal consolidation in full. That leaves the risks to borrowing, and to further tax rises, firmly tilted to the upside.
