UK Budget: Britain is reverting to austerity. Here because


London
CNN business

The last time a UK finance minister revealed tax and spending plans, markets went haywire and the country’s prime minister eventually lost his job. The new government is not looking for a repeat.

On Thursday, Chancellor Jeremy Hunt is expected to unveil a budget that will aim to restore confidence in the UK’s ability to manage its public finances. But that might be easier said than done.

The country is facing a grueling recession and investors remain nervous as interest rates rise. This requires Hunt, who acknowledged that Britain faces “extremely difficult” decisions, to pull off a delicate balancing act.

Media reports indicate the government is looking to raise between £50bn ($59bn) and £60bn ($70bn) through a mix of tax increases and spending cuts, many of which may not take effect until until after the next election in 2024.

“If you do too much, too soon, you risk making the recession worse,” said Ben Zaranko, senior research economist at the Institute for Fiscal Studies. “If you postpone everything until after the next election, you risk not being seen as credible.”

A new wave of austerity could help restore the government’s reputation in financial markets after former Prime Minister Liz Truss’s budget – which included an unorthodox combination of major tax cuts and increased lending – sparked panic.

But it will do little to ease fears about the country’s gloomy economic outlook. The UK is one of two G7 economies to have contracted in the third quarter. It is now smaller than it was before the coronavirus pandemic. The Bank of England predicts a protracted recession, which could extend into 2024.

Further cuts could make matters worse. When the government adopted an austerity program in 2010 in the wake of the Great Recession, it cut 1% of the country’s GDP, according to the UK’s budget watchdog. Just four years ago, former Prime Minister Theresa May pledged to end nearly a decade of austerity.

Now, tax hikes could further depress consumer confidence – already close to an all-time low – and spending cuts risk further straining public services which are already collapsing under enormous pressure.

However, Hunt intends to demonstrate that he has a plan to reduce public debt as a proportion of GDP over the medium term. It is currently at 98%. The Office for Budget Responsibility said in July that it could hit nearly 320% in 50 years.

“We need to make some tax increases, make some spending cuts, if we are to show that we are a country that pays our way,” Hunt told Sky News on Sunday.

How did the UK get here? There is no shortage of pointing fingers.

Part of the problem is global in nature. Interest rates have risen rapidly around the world as central banks attempt to curb inflation. This has raised borrowing costs for the government, inflicting a shock after years of cheap money.

At the same time, skyrocketing energy costs, exacerbated by Russia’s war in Ukraine, have forced governments to step in to cushion the blow of crippling energy bills, shortly after spending huge sums helping families and businesses during the pandemic.

Hunt scrapped plans to cap energy bills for typical households at £2,500 ($2,981) for the next two years. Instead, support will only be guaranteed until next spring. But the measures will still prove costly.

However, the government cannot blame all of its problems on the rest of the world.

“Just look at how the UK is performing compared to all the other countries in Europe, and it’s obvious there’s a UK-specific element to that,” Zaranko said.

The UK’s exit from the European Union has weighed on trade and exacerbated worker shortages in key industries. It has also contributed to a devaluation of the pound – down about 20% against the US dollar since the Brexit vote in 2016 – which has helped fuel inflation by pushing up the price of imports.

“The UK economy as a whole has been permanently damaged by Brexit,” former Bank of England official Michael Saunders told Bloomberg TV this week. “If we hadn’t had Brexit, we probably wouldn’t be talking about an austerity budget this week. The need to raise taxes, there would be no spending cuts”.

And while US inflation cooled more-than-expected in October, falling to 7.7%, it’s still surging sharply in the UK, hitting a 41-year high of 11.1% last month.

This reinforces expectations that the Bank of England will need to keep raising interest rates and could keep them higher for longer, although the recession may complicate those predictions.

The country’s job market also remains extremely tight, with employment rates lower than before the coronavirus and a record number of people out of work due to long-term illnesses.

“The UK stands out in that the supply of jobs has been very limited, perhaps more so than in other countries,” said Ruth Gregory, senior UK economist at Capital Economics.

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