UK’s taxes are at a 70-year high. But its finance minister won’t splash the cash at upcoming Budget

LONDON — British Finance Minister Jeremy Hunt will deliver the government’s Budget commitments on Wednesday against a better-than-expected economic backdrop, but economists expect him to stay cautious for now.

In his Autumn Statement in November, Hunt delivered a £55 billion ($66 billion) package of tax rises and spending cuts in a bid to plug a substantial hole in the country’s public finances and restore its fiscal credibility. 

A marked improvement in the country’s fiscal position and a sharp reduction in wholesale natural gas prices since Hunt took office late last year propelled the government to a surprise £5.4 billion budget surplus in January.

Public sector borrowing has also undershot by around £30 billion year-to-date, economists noted this week, in part reflecting higher-than-expected tax receipts. This will lend credence to Hunt’s aims of bringing public sector net borrowing below 3% by 2027/28.

However, the U.K. remains the only G-7 major economy yet to fully recover its lost output during the Covid-19 pandemic, and households continue to battle a cost-of-living crisis due to sky-high food and energy bills.

The U.K. economy flatlined in the final quarter of the year to narrowly avoid entering a technical recession, though suffered a sharp slump in December. New data Friday showed the economy grew by an annual 0.3% in January, exceeding expectations.

The independent Office for Budget Responsibility late last year predicted the sharpest fall in living standards on record amid a five-quarter recession, with GDP contracting by 1.4% in 2023.

Deutsche Bank suggested in a note Wednesday that this will likely be revised up to just a 0.5% contraction, in line with the Bank of England’s forecast for a shallower downturn.

‘Money to play with’ but ‘no frills’ this time

In a research note last week, BNP Paribas Chief European Economist Paul Hollingsworth projected that the U.K.’s borrowing forecasts will be lowered by £10-15 billion at Wednesday’s budget. 

The French bank estimates that the “improved macroeconomic backdrop and better-than-expected performance in public finances” have afforded the chancellor a £25-30 billion windfall.

But although Hunt is likely to have “money to play with” as falling energy prices, lower short-term interest rate expectations and a more resilient global economy indicate stronger growth in the near-term, Hollingsworth suggested the chancellor will “only give away around half of this” while banking the rest for “likely pre-election giveaways.”

With a general election due before the end of 2024, Prime Minister Rishi Sunak’s Conservative Party trails the main opposition Labour party by at least 20 points in most national opinion polls.

“We expect the chancellor to meet his fiscal targets a year earlier than previously forecast, enhancing his fiscal credibility, following a tumultuous 2022 for the exchequer,” Hollingsworth added.

Setting up for the fall

The apparent turn in fortune has also led to increased pressure on Hunt from within his own party to address the country’s tax burden, which sits at a 70-year high.

The Autumn Statement increased business taxes from 19% to 25% for the financial year beginning April 1. Hunt told CNBC last month that taxes for both businesses and individuals will be cut “as soon as we can afford to.”

After the market chaos unleashed by September’s tax-cutting “mini-budget” in the context of high inflation, which ultimately led to former Prime Minister Liz Truss’ resignation, Barclays also expects Hunt to resist calls to spend heavily in this cycle and instead focus on “modest measures to relieve pressures on households.”

The British bank projected a small fiscal easing package totaling around £4 billion in 2022-23, with around £13 billion next year and £7 billion per year thereafter. 

“Measures are likely to include keeping the Energy Price Guarantee unchanged at £2,500 in Q2, freezing fuel duty for another year, and offering more money to government departments to allow pay rises of c.5% in 23-24, rather than the 3.5% currently budgeted,” Barclays Chief European Economist Silvia Ardagna predicted.

In November, Hunt set out plans to raise the government’s energy price cap for a typical household from April 1 to £3,000 per annum from its current level of £2,500.

Deutsche Bank Senior Economist Sanjay Raja suggested Hunt will deliver a “no frills” budget focused on the cost-of-living crisis and public services. He agreed that fuel duty will remain frozen and suggested energy subsidies for households and businesses will be maintained for the next three months.

Like BNP Paribas, Deutsche expects public sector pay to be upped by 5% in a bid to break the deadlock in pay negotiations between the government and multiple unions.

The country has been beset by widespread industrial action from rail and postal workers, nurses, doctors, teachers, lawyers and civil servants over the past six months.

“Looking to the future, we expect the Chancellor to hint at some further fiscal loosening later this year. Under the current fiscal rules, and updated projections, we think that the Chancellor will have roughly GBP 13bn in headroom to get underlying debt-to-GDP down in 2027/28 – a slim margin by historical standards, but an improvement relative to last year’s forecast nonetheless,” Raja said.

“This, we think, could give way to a more generous Autumn Statement later this year with some modest tax cuts and spending giveaways likely.”