Analysis |  UK's Balanced Budget Act must be credible for markets

Analysis | UK’s Balanced Budget Act must be credible for markets


Britain’s Chancellor of the Exchequer Jeremy Hunt has the unenviable task in Thursday’s autumn statement of balancing the nation’s books without plunging it into recession. The reaction of the bond market will tell us if it has found the right balance.

The size of Britain’s fiscal hole, allegedly as deep as £50bn ($59bn), will be revealed with the concurrent release of financial estimates from the Office for Budgetary Responsibility. Satisfying the watchdog’s basic requirement of balancing government spending with revenue over a prescribed period of time, so that the ratio of debt to gross domestic product does not increase, is Hunt’s primary goal. . The OBR verdict will make or break this latest iteration of a Conservative government, as the failure to uphold economic competence was what doomed the previous Truss administration. But there is another public body with which Hunt must coordinate closely to restore stability and prosperity: the Bank of England.

The catch is that the OBR’s forecasts, which feed directly into the central bank’s models, look out five years, while the BOE’s horizon is two years shorter. The government is currently aiming to balance the books over three years, although Hunt is almost certainly extending it. Any spending cuts or tax increases that Hunt pushes back beyond three years are fundamentally irrelevant to the BOE, as it cannot model the impact of either on growth or inflation. So, to influence the BOE’s forecast, the fiscal tightening must be applied over the next two years and be large enough – tens of billions of pounds – to be taken into account.

But what makes sense economically and for market credibility may clash with political reality, especially if tax increases irritate an already turbulent Conservative party. This is where realpolitik comes in for Hunt and Prime Minister Rishi Sunak: choosing their poison wisely will not only determine the future of this Conservative government, but also how the Conservative Party is perceived as the next election approaches. , expected in two years.

The ultimate test will be how Thursday’s package affects the value of sterling and gilt returns. On his way to the G-20 meetings in Bali, Sunak told reporters earlier this week that putting public finances on a sustainable path was essential to “meet the expectations of international markets”. The government is well aware that it cannot afford to trigger the kind of collapse in the government securities market that brought down Liz Truss after just 44 days in office.

Hunt will no doubt use sleight of hand to push spending cuts as far back as possible on the OBR’s five-year schedule. Fiscal slowing — not matching spending increases to inflation and leaving tax thresholds unchanged so real incomes fall — is the stealthier route. Such opaque measures are far from an honest solution; but promising to be frugal after the next election will not pass the mark.

So there must be a sufficient increase in short-term revenue through increased tax levies combined with sufficient spending restraint to maintain calm in the gilt market. The BOE needs to be convinced that a firm grip on public finances will complement its efforts to contain double-digit inflation. Only then can it begin to slow the pace of interest rate hikes.

With the current energy price cap set to expire in April, the reduced but still substantial cost of a tiered replacement focused on the most needy, which is expected to be announced on Thursday, will also need to factor into the price forecast. consumption. As Ana Andrade and Dan Hanson of Bloomberg Economics put it this week, “Hunt has more say in 2023 inflation than the BOE.”

But Hunt will also want the chance to offer some relief from the relentless pace of austerity ahead of the election. It’s going to take some ingenuity not to get too “tearful” with this week’s fiscal tightening, as Hunt has repeatedly warned. He certainly paved the way for everyone to pay more taxes, and in multiple ways.

The gilt market will closely monitor government borrowing needs for the rest of the year. There may be a slight reduction in net cash requirements, allowing fewer gilts to be sold through April. However, Hunt may choose not to release debt sales, knowing that next year’s needs will be much greater. A Bloomberg survey of five gilt traders showed an average expectation of £250bn in issuance over the next financial year; on top of that, the BOE is expected to sell around £50bn of its QE stock, with a similar amount not reinvested at maturity. The OBR forecast will set the longer-term tone for how bond markets will deal with increased supply.

The more Hunt can do now to tighten the fiscal stance, the less the BOE will have to do on the monetary front. Unfortunately, suffering too much fiscal hardship from the start will push the economy into a worse recession than it probably already is, weakening the pound and deepening the hole the government is trying to escape from. Closing the fiscal gap without harming short-term growth will not be easy, while runaway inflation must be brought under control. But having the government and the central bank on the same page, under the careful scrutiny of the OBR’s independent watchdog, would be a good start.

More from Bloomberg Opinion:

• Will Sunak test the love of Britain’s Top 1%? : Therese Raphael

• The cost of living crisis is a slow burn for UK consumers: Andrea Felsted

• British families are being hit by stealth taxes: Stuart Trow

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.

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