Austerity 2.0

Austerity 2.0

Last week’s UK Autumn Statement involves a major tightening of fiscal policy, similar to the consolidation launched by a previous Conservative chancellor, George Osborne, in 2010. Whereas the 2010 tightening was launched into an economy that was growing, today’s tightening will hit an economy that is in recession.

• The UK has seen a remarkable U-turn on fiscal policy in the last two months. On 23 September, the previous chancellor, Kwasi Kwarteng, announced the largest tax cuts in 50 years and a major easing of fiscal policy. Those cuts were first reversed and now, under a new chancellor, Jeremy Hunt, fiscal policy is being tightened.

• After the financial market turmoil unleashed by the mini-budget, Mr Hunt’s Autumn Statement signals a return to fiscal orthodoxy. But an era of low interest rates, and cheap borrowing costs for government, is over. Interest costs have risen sharply this year and the Office for Budget Responsibility (OBR) expects government debt interest payments to rise above spending on any public service except the NHS by 2027-28. Governments, in the UK and elsewhere, need to find more money to pay interest costs. The fate of the UK mini-budget shows governments also need to maintain the confidence of financial markets.  

• While Mr Osborne’s deficit reduction programme was focussed on cutting public spending, Mr Hunt expects tax rises to do more of the heavy lifting. Under his plans, the tax take is forecast to rise to its highest level since the second world war. The greater reliance on tax rises partly reflects a view that, with public services under pressure and the economy in recession, there is less room to cut spending. Nonetheless, more than half of this retrenchment is to come in the form of spending cuts.

• Given the cost-of-living crisis and an economy in recession, the chancellor has pushed most of the pain of spending cuts into the future. A cynic might note that some of the most politically difficult reductions have been delayed until after the next general election.

• Mr Hunt has also had to ease the rules governing fiscal policy. As has happened previously in the recent past, a chancellor, faced with a slowdown and rising borrowing, has shifted the goalposts. Mr Hunt has scrapped the previous rule that required the elimination of borrowing for current spending and extended the time to get government debt on a downward trajectory.

• Even with a less demanding fiscal target the government faces an uphill task of reducing debt in the current environment. The OBR says that the UK economy is in recession and that GDP will not return to its pre-pandemic peak until 2025. The OBR believes that UK households will endure two consecutive years of the sharpest contractions in disposable income on record. Mr Hunt’s plans to right the UK public finances could easily be blown off course by more persistent inflation or a deeper downturn than expected by the OBR.

• Mr Osborne’s austerity drive shows how difficult it is to reduce government debt even when the economy is growing. By 2015, Mr Osborne had achieved only half the consolidation he had aimed for in his June 2010 budget. The success of this Autumn Statement, like its predecessors, will not be judged by the government's ability to deliver it to the letter. It will be judged more on its ability to deliver a credible reduction in debt over time.

• For all the talk of austerity, the UK public sector is, with the exception of the pandemic, larger today as a share of GDP than at any time since 1975. Nor, despite sharply rising levels of public borrowing, have taxpayers got off lightly. Taxes now account for a larger share of GDP than at any time since 1950. Whichever party wins the next election will face a daunting combination of a large, but still-stretched public sector, high levels of taxation and elevated public debt.

PS: The OBR is rather more optimistic on UK house prices than we are. It forecasts a 9% drop in prices against our forecasts for a decline of 15%.

PPS: My colleague Edoardo Palombo last week updated our Financial Stress Index. The index has risen sharply driven by sharply higher gilt yields and market expectations for interest rates in the wake of the mini-budget. The index is now at the highest levels since 2010 testifying to a significant tightening of financial conditions.

For the latest charts and data on health and economics, visit our Economics Monitor:
https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.html

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.9% at 7,386.

Economics

• UK chancellor Jeremy Hunt set out the UK government’s spending and tax plans in his Autumn Statement
• Mr Hunt announced a rise in the cap on UK domestic energy prices, taking the bill for the average household from £2,500 a year to £3,000 a year from April 2023. Substantial support for vulnerable groups was announced alongside this measure
• Mr Hunt announced a number of tax-raising measures including a freeze in Employers’ National Insurance, an extension and increase to windfall taxes on oil and gas companies, a new windfall tax on electricity generators, an extension to the freezing of income tax thresholds and a reduction in the threshold of the 45% additional income tax bracket from £150,000 to £150,040
• Owners of electric cars will have to pay Vehicle Excise Duty from 2025
• UK unemployment fell to 3.6% in the three months to September compared with the previous quarter. However economic inactivity increased by 0.2 percentage points to 21.6%, driven by a rise in long-term sickness which now stands at record-high levels
• Average regular pay in the UK rose by 6.6% in July to September compared with the same quarter last year, well below estimates of inflation. Public-sector pay growth was just 2.2% over the same period
• UK inflation rose to 11.1% in the 12 months to October, its highest level in 41 years. The cost of electricity, gas and other fuels rose by 90% while food prices were up by 16.2%
• The euro area posted GDP growth of 0.2% in the third quarter compared with the preceding quarter
• US existing-home sales fell for the ninth consecutive month, the longest decline on record, in a sign that high mortgage rates have hit demand 
• The US’s second-largest LNG terminal, which was damaged in an explosion in June, announced that it would only resume full operation in March 2023, later than expected. The development will lower global supplies of LNG
• The global population hit 8bn last week, according to UN estimates. It will reach 9bn in 15 years. Alongside population growth, the world’s population is also ageing, with the median age up to 30 years from 22 years in 1950

Business

• John Ray III, appointed as chief executive to manage the bankruptcy of cryptocurrency exchange FTX, said that: “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information”. Mr Ray oversaw the liquidation of Enron
• Amazon announced that it would lay off 10,000 employees, the latest in a string of job cuts in the troubled technology sector
• Elizabeth Holmes, founder of failed start-up Theranos, was jailed for over 11 years for fraud after it emerged that claims that Theranos had developed revolutionary medical technology were false. The move is seen as a warning to other start-ups making exaggerated claims over their products
• The football FIFA World Cup began in Qatar yesterday

Global and political developments

• Countries meeting at the UN-organised COP27 climate summit agreed to set up a fund to compensate poorer countries for the “loss and damage” caused by historical carbon emissions
• G20 leaders who met in Bali, Indonesia issued a joint declaration stating that “Today’s era must not be one of war” and that “It is essential to uphold international law and the multilateral system that safeguards peace and stability”. The majority of leaders condemned the war in Ukraine
• A Dutch court sentenced three men with links to the Russian military to life in prison for their role in the downing of Malaysian Airlines flight MH17 over eastern Ukraine in 2014. The men are unlikely to be extradited by Russia
• A missile hit eastern Poland, killing two people. Polish authorities have said that they suspect the missile is a Ukrainian air defence missile that malfunctioned while intercepting a Russian missile although Ukraine denies this
• Ukrainian officials report that fighting has intensified in the Donetsk region with Russian troops previously deployed in the Kherson region “redirected” to the eastern province
• Final results from US mid-term elections saw the Republican Party take back control of the US House of Representatives and the Democrats maintained control of the US Senate
• Former US president Donald Trump said he would run again in 2024 although candidates backed by former president Donald Trump in the mid-term elections are widely judged to have underperformed

And finally… Sky News reported last week that physicist and television presenter Brian Cox struggled to check into a hotel in Manchester as Scottish actor Brian Cox, well known for playing Logan Roy in Succession, was already staying there – the Brian sleeps tonight