Sunak set to keep fiscal squeeze in spite of boost from economic upgrades

The Office for Budget Responsibility is set to revise down its estimate of long-term scarring to economy from the pandemic.

Holly Williams
Sunday 24 October 2021 09:00
The Chancellor is expected to hold firm on plans to repair Britain’s finances (Stefan Rousseau/PA)
The Chancellor is expected to hold firm on plans to repair Britain’s finances (Stefan Rousseau/PA)

The Chancellor is expected to hold firm on plans to repair Britain’s pandemic-hit finances in his Budget on Wednesday despite being offered some economic wiggle room by the UK fiscal watchdog.

The Office for Budget Responsibility (OBR) is expected to deliver a raft of economic upgrades as Britain recovers faster than expected from the Covid-19 crisis.

With the economic picture looking rosier than at the year’s first Budget in March, the independent forecaster is expected to up its growth outlook for 2021, cut its unemployment prediction and pencil in lower borrowing thanks to higher tax receipts.

We expect the Budget to be devoid of measures that would significantly ease the fiscal squeeze that households and firms are set to endure over the months ahead

Samuel Tombs, Pantheon

It is also set to revise down its estimate of long-term scarring to economy from the pandemic, from its previous prediction it will be 3% smaller in five years’ time due to the pandemic.

However, experts predict that despite the fiscal windfall, Rishi Sunak will not loosen the grip on his fiscal squeeze as the recovery starts to slow and with soaring inflation meaning higher interest payments on the UK’s mammoth debt pile.

Having also paused his previous fiscal rules during the early days of the pandemic, he is thought to be planning to introduce new ones that will likely stay his hand.

Martin Beck, senior economic advisor to the EY Item Club, said: “The Chancellor certainly has some room for manoeuvre next Wednesday given the economy has outperformed the OBR’s March forecast. ”

He added: “That said, this is unlikely to prompt a fiscal loosening. The Chancellor’s September decision to fund extra health and social spending wholly with tax raises suggests deficit reduction is his priority for the time being.

“While the economy is much-improved since earlier in the year, the recovery is starting to encounter headwinds.”

The EY Item Club believes the OBR will hike its gross domestic product (GDP) forecast for 2021 to growth of 7% from the 4% forecast in March.

It also predicts the OBR will slash its scarring estimate possibly as low as 1%, which could boost the Government’s fiscal position by £25 billion a year by 2025.

Borrowing is also likely to undershoot the March forecast for £234 billion in 2021-22, now expected to come in at less than £200 billion, while the unemployment rate will also fall far short of the 5.6% previously predicted.

But that it likely to be where the good news ends, according to Investec Economics.

It believes the economic rebound may not necessarily be larger than anticipated, but “merely that is has come sooner”.

It is pencilling in growth of 4.8% in 2022, far below the OBR’s projection of 7.3% in March, which will likely also curtail the fall in borrowing after 2021-22.

The public finances will also be dealt a blow by rising interest payments, which already became evident in September’s official borrowing figures – even before any expected interest rate rise.

The Government’s interest payments bill hit £4.8 billion last month, even though borrowing reduced by 24% year-on-year to £21.8 billion.

The Office for National Statistics said this was due to the Retail Price Index measure of inflation rising, which is linked to Government interest payments, as the economy recovers.

Samuel Tombs at Pantheon Macroeconomics said the OBR is set to revise up its forecast for interest payments by £20 billion to £45 billion, or 1.9% of GDP – nearly double the 1% forecast by the OBR in March.

He said: “The Chancellor likely will not have material wiggle room in meeting his new fiscal target, which is widely expected to be to achieve a balanced current budget in three years’ time.”

It is thought Mr Sunak will set himself new fiscal rules to ensure day-to-day spending is no longer to be funded via borrowing within three years and for underlying debt – currently around 100% of GDP – to decline by 2024/25.

Mr Tombs added: “As such, we expect the Budget to be devoid of measures that would significantly ease the fiscal squeeze that households and firms are set to endure over the months ahead.”

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