By Eiko Sievert, Director, Sovereign and Public Sector

Restoring Britain’s reputation for sound government finances will depend on implementing a mix of tax increases and spending cuts which will be deeply unpopular with influential wings of the ruling Conservative Party, as well as voters trying to cope with the rising cost of living.

The new prime minister, due to be chosen by the party within a week, and Chancellor of the Exchequer Jeremy Hunt, who is not going to run for the premiership, have no easy options to cut back government spending without reducing welfare benefits, pension entitlements, departmental spending and/or public investment. In addition, there is a high likelihood that tax increases will be needed in the form of higher windfall taxes on energy firms, levies on banks and/or a “stealth tax” arising from not adjusting income tax bands to inflation.

Equally, the previous government’s growth forecasts looked unrealistic, standing at 2.5% a year compared with our estimate of the UK’s annual growth potential of around 1.5%.

In addition to the drag from Brexit which has made trading with the EU, the UK’s largest trading partner, more costly and more difficult, higher borrowing costs for the government, businesses and households are also limiting growth in the near to medium term. The British economy will stagnate at best in 2023, with the risk of recession growing.

While not our baseline, there is also the growing chance of an early general election, which would add further uncertainty to the longer-term fiscal outlook.

Still, the UK (AA/Stable) retains important institutional strengths as the recent weeks have demonstrated.

The Bank of England stepped in successfully to avert a financial crisis after the Truss government had announced a “mini budget” including huge unfunded tax cuts.

Chancellor Hunt has promised to include Office of Budget Responsibility forecasts when preparing his new budget, due 31 October, something his predecessor had decided against doing. The new budget should help further calm financial markets which had steadied before Truss’s resignation and have remained stable, with the yield on 10-year gilts at around 3.9%, down from its early October peak of around 4.5%.

For a replay of Scope Rating’s webinar on the outlook for the UK budget challenges, please follow this link:

UK budget: can the UK restore fiscal credibility?

Download the presentation slides