In an ideal political world, UK Chancellor of the Exchequer Jeremy Hunt would use Wednesday's annual budget to sway voters into keeping his
embattled Conservative Party in power at the coming election by serving up a platter of tax cuts. The memory of the gilt-market meltdown triggered by then-Prime Minister Liz Truss's disastrous 2022 fiscal adventure means he's going to have to be far more prudent.
Hunt will announce the latest economic and fiscal estimates from the Office for Budget Responsibility that will frame his spending and tax-raising limits. It's a self-imposed straitjacket over a five-year horizon, which will be especially limiting this time around as the economy is stuck in recession with increasing spending demands coming from all angles. But avoiding another breach of fiscal rectitude has so far been the main attribute of Hunt's tenure. He simply can’t afford to stray too far from the path of economic righteousness.
However, there may be one silver lining to this begrudging prudence — if it ameliorates the Bank of England's concern that fiscal stimulus risks reigniting inflation. The knock-on effects of a 10 percent rise in the minimum wage delivered in the Autumn budget statement aren’t yet clear in the BOE's determination. Keeping budget giveaways to a minimum may not please Hunt's backbenchers — but they’re not the only audience he has to placate.
Any interest-rate cuts later this year from the BOE are likely to have more resonance in restoring economic confidence than modest tax cuts anyway. With over a million more homeowners having to refinance mortgages at much higher interest payments, there's a wider balance to be struck. Besides, there's been no discernable shift in voting intentions since January when Hunt's 2 percentage-point reduction in national insurance, a payroll tax, came into effect. The opposition Labour Party has maintained a consistent 20-point lead in recent opinion polls, suggesting an assured victory at the general election that will most likely be held this autumn.
At best, Hunt may be able to squeeze a repeat cut in NI, which will cost around £9 billion ($11 billion). If he opts for a similar reduction to the basic rate of income tax, it would cost 50 percent more, as it affects a wider base, and likely use up all of his available fiscal headroom. Hunt, like all chancellors, delights in the theater of revealing several different types of rabbits from his magic money hat. He's preannounced a series of business-investment incentives, but no doubt there will be a few more sparklers.
Balancing this will be measures to raise revenue by tightening tax loopholes and hitting in-vogue political targets. The roster of possibilities includes raising levies on non-domiciled residents, increased duties on holiday lets, vaping and business-class airfares, as well as extending windfall taxes on North Sea hydrocarbon production. Much of this will be about purloining Labour's prospective agenda, which has become something of an art form for Tory chancellors.
While the main focus will be on how much Hunt bribes taxpayers with their own money, there’s a more tangible announcement to focus on. The size of government borrowing for the next financial year will be revealed by the Treasury's Debt Management Office, with gilt sales forecast to rise by nearly 10 percent for the next financial year to around £260 billion. This will introduce another net record of annual supply in the coming year.
After redemptions of around £140 billion, net new issuance may appear less than the pandemic-inspired bulge to nearly £500 billion, but that excludes one major swing factor: the central bank. From being the biggest buyer in the room, effectively taking down all net government issuance, the BOE has shifted aggressively into reverse. It’s reducing its stockpile by more than £100 billion annually, including active sales of longer-dated bonds.
UK government bond yields have risen sharply this year and are higher than their euro-zone peers, leaving them sensitive to yet more supply pressure. The DMO has a fine record of not surprising the market by laying out its plans far in advance, and has steadily trimmed the size of long-dated auctions to reflect waning demand from domestic pension funds. But even modestly larger-than-expected issuance could trigger market dislocation. Hunt will need to tread carefully in how he funds his political ambitions to ensure the bond-market vigilantes don't ride again.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
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