Key Takeaways
- Later this week the UK Chancellor, Rachel Reeves, will present her Spring Statement, which includes a fiscal outlook and public spending plan.
- The Chancellor’s fiscal rules aim to balance current spending with taxes, but high public debt and interest rates make this challenging.
- The Office for Budget Responsibility’s preliminary update showed that lower growth and higher debt interest have tightened the fiscal space.
- To address the fiscal challenges, the government may need to target welfare cuts, increase taxes, and ease the primary fiscal rule.
- Despite the challenging outlook, falling energy prices could boost economic growth and help lower interest rates in the future.
This week sees the UK Chancellor, Rachel Reeves’, Spring Statement. It’s not a Budget – we’ll get that in the Autumn – but a review of the fiscal outlook and a plan for public spending. It will also contain an updated forecast from the independent Office for Budget Responsibility – the OBR – and it won’t look good. We look at the options and discuss what it means for UK prospects.
In her first Budget, Rachel Reeves announced a huge increase in taxes and a new set of fiscal rules. The goal was to restore stability and faith in the public finances. The main rule was to bring the current budget into balance. In other words, current spending would be met by taxes. Capital spending would be excluded. Sounds sensible and most economists would agree, provided the capital was spent wisely. The problem is that this implies a very tight policy – challenging when public debt stands at 100% of GDP and interest rates are more than 4%. The UK is suffering from low growth and a rising bill for welfare and health care. Rachel Reeves’ fiscal rule risks squeezing the economy with ever higher taxes and declining public services.
The preliminary update from the OBR a few weeks ago showed that the room which Rachel Reeves had under her fiscal rules had all but gone due to lower growth and higher debt interest. Only by cutting welfare and restricting public spending has she recovered the position. But the implied path for public spending especially on unprotected areas outside health and defence is implausibly tight.
So what to do? Better economic growth would improve everything of course and the government has certainly got the message with its growth agenda. I do think that unblocking the planning system can produce significant benefits quickly but increasing overall growth is incredibly difficult.
There are three things that could be done:
- First, the welfare bill should continue to be targeted. The £5bn in cuts announced last week is merely a reduction in the increase. To restore it to the level of 4 years ago would require £20bn in cuts. More reform is needed. It is painful but the UK has seen similar reductions before. Moreover, reform would mean more people in work which would further improve public finances.
- Second, although there will be no tax increases announced this week they will likely go up in the Autumn. Indeed, they are already going up. Stamp Duty on housing goes up next week and a whole range of tax thresholds are frozen, so the tax take will rise.
- Third, the primary fiscal rule needs to be eased. Instead of perfect balance, there should be a range, say up to 1% of GDP. That would still mean that the second fiscal rule, that public debt declines as a share of GDP is met.
Life will get even tougher for Rachel Reeves when the OBR abandons its implausibly optimistic assumption on UK growth. But it’s not all bad news. As we’ve discussed before, energy prices are set to tumble over the next few years and that will boost economic growth and could help to lower interest rates.
So, I’m afraid to say that the outlook for the UK is grim. High taxes will go up further, the health and welfare bill will squeeze other public spending, growth may improve a little in the medium term but will remain subdued. Inflation should fall substantially in 2026, and interest rates should go down too but it’ll be a hard grind.
