Economic outlook: Upcoming Budget will be pivotal

In the latest in a series of articles, former Agent of the Bank of England, Phil Eckersley, offers some insights on the UK economy.

In terms of growth, the UK economy remains in the doldrums, seemingly unable to break out of the numerous constraints holding it back.  The latest forecasts by the Office for Budget Responsibility, Bank of England, International Monetary Fund and World Bank offer little comfort to policy makers and politicians. 2025, in line with recent years, is likely to achieve 1.0-1.5 % growth.  Inflation remains elevated, entrenched at 3.8% according to the latest data released by the Office for National Statistics for September this year.   

In recent months Consumer Price Index has been boosted by cost pressures, particularly labour and rising food prices. The latter amplified by poor harvests and higher processing costs, with higher labour costs blamed on the National Insurance raid and increases in the National Minimum Wage.  Despite rising wage costs, the labour market has clearly turned with rising unemployment and falling vacancies. Indeed, the annual rise in unemployment in August (repeated in September) triggered the Sahm rule which predicts a recession if unemployment rises more than 0.5% in a year.  It is an economic truism that without a productivity miracle (and one seems a long way off), an economy cannot grow unless employment does.

So, what’s round the corner?

Bank policy makers face the dilemma of low growth and above-target inflation, suggesting a simultaneous loosening and tightening of bank rate. Rising gilt yields at the long end and persistent inflation suggest rates will remain higher for longer.  Markets are now betting on one less rate reduction over the next year.    

Furthermore, we await the outcome of the Budget later this month with plenty of speculation around the size of fiscal hole that the government needs to plug.  To exacerbate matters, many businesses face the impact of additional employment rights for workers as the latest legislation moves through its Parliamentary stages.

And to the Budget specifically

As the UK approaches the November Budget, public finances are under pressure. Economic growth remains sluggish, set against a backdrop of persistently low productivity.  The OBR is expected to downgrade its trend productivity forecasts — by as much as 0.3 percentage points — imposing another fiscal hit.

In a low growth environment, this fiscal deficit intensifies pressure on the Chancellor to extract the proverbial “rabbit from the hat” by delivering revenue increases or spending cuts. Despite the government having pledged not to raise its main sources of revenue – income tax, VAT, or National Insurance Contributions (NICs).  Adherence to this election pledge leaves minimal headroom.  It suggests more targeted tax changes are on the cards.  Media speculation suggests these could include tweaks to pensions relief, salary sacrifice rules or tightening avoidance measures.  More recently, however, government officials have refused to rule out a rise in income tax offset by a reduction in NICs which would raise revenue while at the same time (it could be argued) not affecting working people.

The alternative, of course, is to cut spending.  The government’s 2025 Spending Review laid out modest increases across departmental budgets and major capital investment commitments (e.g. in infrastructure, clean energy and housing) to underpin longer-term growth.  Politically, however, this will prove difficult as attempted reforms to the welfare budget demonstrated last year).

In essence, the government is walking a tightrope; attempting to achieve fiscal consolidation while simultaneously protecting growth, notwithstanding trying to navigate an increasingly hostile political environment.

So, how big is the problem?

The government deficit was over £20bn in September, which is the highest on record outside covid and despite revenues rising year on year due to large contributions from fiscal drag and higher National Insurance Contributions. 

State spending has ratcheted up along with the cost of servicing debt. This year monthly debt interest, for example, is roughly double what it was a year ago.  

Conditions are more challenging because of two fundamentals. The Bank of England’s quantitative tightening programme and the composition of the debt.  The former is increasing supply of gilts into the market pushing down on price and up on yield.  However, at its latest meeting the Bank’s Policy Committee announced measures to ease some of the pressure on government debt by selling a smaller proportion of longer-term gilts into the market and by reducing the stock of sales.  These palliatives may only provide limited respite, a proverbial sticking plaster.  

The compositional effects are two-fold: the government lured bond holders by offering inflation-proof debt – so-called linkers or index-linked gilts – in exchange for lower upfront costs. This strategy works if inflation stays low.  Now, with a quarter of the UK’s debt stock rising with inflation, if prices rise faster than expected, the hole in the public finances will expand further.  Also, recent issuance of debt has tended to be at the long end where borrowing costs are higher.  Thus, the full benefits of MPC decisions, affecting near term interest rates, have not flowed through to the cost of government debt.  The corollary is that the servicing cost of UK debt is now over £100bn annually, more than the cost of most government departments. 

Rachel Emmerson, Partner and Editor of Pathfinder for business, comments; “In an uncertain economic environment, businesses should focus on what they know and what they can control, while preparing to adapt to changes with agility. Whether that is maintaining healthy cash reserves, closely monitoring cashflow, strengthening relationships with customers or suppliers to reduce risk, or reviewing their vision and long term goals to ensure they remain relevant.  

“It’s also important to lean on trusted professional advisers who have experience guiding businesses through similar challenges. We are here to support our clients throughout changes and challenges, so if you need additional guidance, please don’t hesitate to get in touch”. With the UK economy under pressure and fiscal policy at a crossroads, the upcoming Budget will be a pivotal moment for businesses and individuals. 

Following the Chancellor’s announcement on Wednesday 26 November, we’ll be hosting the Autumn Budget question time webinar on Friday 28 November, where our panel of tax and business experts will unpack the key measures, share practical insights and guidance, and answer your questions to help you navigate the changes. You can register here.