The UK government will usher in a new era of austerity in an effort to restore market confidence

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

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LONDON – Britain’s new finance minister Jeremy Hunt must weigh the country’s economic danger against his party’s political survival on Thursday as he delivers a long-awaited tax return.

Hunt is expected to announce tax increases and spending cuts totaling between £ 50 billion ($ 58.85 billion) and £ 60 billion annually as he attempts to plug a substantial hole in the country’s public finances by reassuring the market of his. fiscal credibility after the chaos unleashed by former Prime Minister Liz Truss’s disastrous “mini-budget” in late September.

The Bank of England predicted the UK to be at the start of its longest recession on record and on Friday the Office for National Statistics confirmed that GDP contracted 0.2% in the third quarter of 2022.

The Bank is also trying to push inflation back to its 40-year high target of 10.1% in September and imposed its largest interest rate hike since 1989 earlier this month.

“We will see everyone pay more taxes. We will see spending cuts,” Hunt told the BBC on Sunday, also promising that the government would unveil a new and more targeted plan to help with household energy bills beyond April.

Reports have suggested that many of the more radical austerity measures enacted by the new Prime Minister Rishi Sunak’s government will take effect from 2025 onwards, following the upcoming general election.

“The government and the Bank of England are in a very difficult position, because the choice of chancellor next week is not so much about what will happen: it has already told the market that the forecast of the debt must go down over the next few years. , it’s quite time, ”Hugh Gimber, global markets strategist at JPMorgan Asset Management, told CNBC on Friday.

He added that Hunt faces a key decision between anticipating the pain that the Sunak government has promised to rebalance the economy and delaying the large impact of the new measures in order to prevent further political damage, at the risk of prolonging the crisis.

“At the moment, you can economically support a strong argument to say anticipate it, carry it forward, reduce the amount the Bank of England has to do in terms of trying to slow the economy, but politically, clearly there is a tough challenge there. “Gimber said.

Most election polls in recent weeks give the main opposition Labor Party about 20 points ahead of Sunak’s ruling conservatives, indicating that the damage suffered during Truss’s 45-day tenure and the series of scandals that have plagued the his predecessor Boris Johnson were not dissolved by Sunak’s promise of a return to fiscal credibility.

Spending cuts against tax increases

Thursday’s statement will be accompanied by a long-awaited series of projections from the UK’s independent Office for Budget Responsibility (OBR) and, following the Bank of England’s gloomy outlook a couple of weeks ago, economists expect it to emerge. an equally depressing picture.

On a Monday note, German bank he said the OBR is likely to project a “deep and protracted recession” in 2023, with growth remaining subdued no earlier than 2025 and inflation projections to rise significantly to reflect more persistent price increases.

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

“All in all, the difficult economic outlook is likely to underline the main reason for the size of the fiscal hole, with our loan projections hitting slightly above £ 90bn in 2026/27 (OBR spring statement. 32 billion pounds) “, head of Deutsche Bank UK This was stated by economist Sanjay Raja.

Raja predicts that spending cuts and tax hikes will be split 60:40 in Hunt’s plans, though he said this would be done “invisibly”, with tax hikes focused on freezing personal benefits and tax relief. while lowering the additional tax rate threshold from £ 150,000 to £ 125,000 in order to generate more revenue for the Treasury.

“Away from ‘stealth taxes’, we expect to see a couple more options announced
Thursday. Firstly, an increase in the municipal tax with the local authorities has allowed the level of the municipal tax to be raised by more than 3% without a referendum, “Raja said.

“And secondly, an increase in both the duration and size of the unexpected tax on ‘excess profits’ from oil and gas.”

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In total, Deutsche predicts that the “fiscal resilience” resulting from stealth taxes and higher extraordinary taxes will bring the Treasury around £ 35 billion, given high inflation and energy prices.

Spending cuts, once again enforced through “stealth,” could take the form of “nominal cash blocks to departmental budgets,” Raja said, with spending budgets being minimally filled in the future.

“Capex plans are also likely to be curtailed in the coming years and ‘efficiency savings’ are part of the Chancellor’s plans to fill the fiscal gap,” Raja said.

“This will help offset some of the expected spending increases with welfare and pension payments now likely complemented by inflation rather than earnings growth.”

The market waits with bated breath

The market flatly rejected former Finance Minister Kwasi Kwarteng’s September tax cut announcements, with GBP slipping to all-time lows and government bond yields rose so rapidly that the Bank of England was forced to intervene to prevent the collapse of pension funds.

“If he wants to reassure the markets, he will have to announce timely action in the form of a major fiscal tightening. This could aggravate and / or lengthen the recession and eventually create an even bigger fiscal hole,” said Ruth Gregory, senior UK economist. at Capital Economics.

“If it tries to minimize economic pain, it risks upsetting the markets and causing another spike in gilt yields, which would also worsen public finances.”

Capital Economics expects Hunt to disclose fiscal tightening measures to the tune of £ 54 billion, around 1.9% of GDP, but for this to be funded primarily by nuanced tax increases rather than spending cuts, with the largest share being part of the policies “starting later rather than earlier,” Gregory said.

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