The tricky part is that the OBR’s forecasts, which feed directly into central bank models, look beyond five years, but the BOE’s horizon is shorter than two years. The government is currently aiming to balance the books in three years, although Hunt will almost certainly extend that. Any spending cuts or tax increases Hunt pushes beyond three years are essentially irrelevant to the BOE, as it cannot model the impact on growth or inflation. So to sway the BOE’s forecasts, fiscal tightening needs to be frontloaded over the next couple of years and be large enough – tens of billions of pounds – to count.
But what makes sense economically and for market credibility can conflict with political reality, particularly if tax hikes rile an already turbulent Conservative party. This is where realpolitik for both Hunt and Prime Minister Rishi Sunak comes in: choosing their poison wisely will determine the future not only of this Conservative government, but also of how the Tory party is perceived ahead of the upcoming elections. expected in two years.
The final test will be how Thursday’s package affects the value of sterling and gilt yields. En route to the G-20 meetings in Bali, Sunak told reporters earlier this week that putting public finances on a sustainable trajectory is essential to “maintain the expectations of international markets”. The government is well aware that it cannot afford to trigger the kind of gilt market crash that brought down Liz Truss after just 44 days in office.
Hunt will no doubt use some sleight of hand to push spending cuts as far as is credible on the OBR’s five-year timeline. Fiscal resistance – not matching rising spending with inflation and leaving tax thresholds unchanged so that real incomes fall – is the sneakiest way out. Such opaque measures are far from being an honest solution; but promising to be frugal after the next election won’t pass.
So you need enough short-term revenue growth from a higher tax levy combined with enough spending restraint to keep the gilt market calm. The BOE must feel confident that a firm grip on public finances will complement its efforts to contain double-digit inflation. Only then can it begin to ease the pace of interest rate hikes.
With the current energy price cap expiring in April, the reduced but still substantial cost of a scaled-down replacement focused on the neediest, which is expected to be announced on Thursday, will also need to be factored into the consumer price forecast. As Bloomberg Economics’ Ana Andrade and Dan Hanson said this week, “Hunt has more say on 2023 inflation than the BOE.”
But Hunt will also want an opportunity to offer some relaxation from the relentless drumbeat of austerity ahead of the election. It will take some ingenuity not to get too “hallucinatory” with this week’s fiscal tightening, as Hunt has repeatedly warned. He has certainly set the stage for everyone to pay more taxes, and in many ways.
The gilt market will keep an eye on the government’s borrowing needs for the remainder of the fiscal year. There may be a small reduction in net cash requirements, allowing fewer gilts to be sold through April. However, Hunt may choose not to ease the debt sales, knowing next year’s needs will be much greater. A Bloomberg poll of five gilt traders showed an average issuance expectation of £250bn in the next financial year; in addition, the BOE would have to sell around £50bn of its QE stocks, with a similar amount not reinvested at maturity. The OBR forecast will set the long-term tone for how bond markets will cope with increased supply.
The more Hunt can do now to tighten the fiscal position, the less the BOE will have to do on the monetary side. Unfortunately, preempting too much fiscal pain will plunge the economy into a worse recession than it’s already likely to, weakening the pound and deepening the hole the government is trying to get out of. It will not be easy to close the fiscal gap without hurting short-term growth, while rampant inflation needs to be curbed. But having the government and the central bank on the same page, under the close scrutiny of the OBR’s independent watchdog, would be a good place to start.
More from Bloomberg’s opinion:
• Will Sunak test the love of Britain’s top 1%?: Therese Raphael
• Cost of living crisis burns slowly for UK consumers: Andrea Felsted
• British families hit by secret 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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