Falling leaves, rising taxes: is it a cold forecast for the UK?

In contrast to his predecessor Kwasi Kwarteng, this week Chancellor Hunt delivered a sombre message as he presented his Autumn Statement.

At £55 billion, the overall scale of the fiscal consolidation is very much in line with what had been well trailed in the media, but there were key elements that were nevertheless surprises.

There was a more even split between spending cuts (£30 billion) and tax increases (£25 billion) than expected. The multiplier effect is usually greater for reductions in spending, so in theory a focus on tax would have been better for growth; this choice of what in our view could be a growth-negative outcome shows a marked difference in emphasis compared with the last team to occupy No 11.

Energy Price Guarantee

Given the current global macro environment, the Energy Price Guarantee drew a lot of attention.

The increase in the cap from £2,500 to £3,000 as of April 2023 will save £14 billion.

£12 billion of these savings are to be recycled into cost-of-living payments for vulnerable households and those on lower incomes. The net amount of support is slightly lower, but these households generally have a higher propensity to consume, meaning this move may be growth-neutral.

The £500 increase in the cap is small enough to mean that inflation is on course to peak this quarter (Q4 2022) before gradually falling.

We should temper this by pointing out it is still likely to be around 4% at the end of 2023; this will likely keep the Bank of England vigilant in the near term, but ultimately the package is likely to be a drag on their growth forecasts and hence disinflationary.

We therefore continue to think rate hikes will cease early next year, when the bank is likely to have taken interest rates to 4%.

One crucial thing to point out: the chancellor said he expected the pace of fiscal tightening to pick up as growth returns. Without being too cynical, it comes as no surprise that he backloaded the bulk of this to 2025-2027, which would be after the next General Election.

Embracing fiscal discipline

The chancellor also emphasised the UK’s new embrace of stringent fiscal rules.

Debt as a share of GDP must now be falling at the end of a rolling five-year forecast horizon, with net borrowing below 3% of GDP over same period.

Under the Office for Budget Responsibility (OBR)'s projections, debt-to-GDP is expected to peak at 97.6% in 2025/26, edging down to 97.3% in 2027/28. Public sector net borrowing is forecast to be 7.1% in 2022/23, falling to 5.5% in 2023/24.

There is a huge ‘but’ here: we think these forecasts could be too optimistic.

The OBR’s own GDP forecast has a 2% fall in GDP followed by a rapid recovery – if this recovery falters as we expect it to, it would put the UK’s compliance with its own fiscal rules in jeopardy.

This would lead to more borrowing than is currently anticipated, so let’s turn to gilts.

Gilt supply cut this year…  

The Debt Management Office’s remit for gilt issuance in the current fiscal year has been cut by £24.4 billion to £169.5 billion. The issuing authorities are showing themselves to be sensitive to recent market developments by bearing down on both long-dated and inflation-linked supply within the overall mix.

Long-dated bonds make up just 23.5% of the funding mix: the lowest since share since 2008/9. Inflation-linked bond supply has been slashed to just £17 billion: the lowest in nominal terms since 2007/08.

There is a revealed sensitivity here to the recent volatility in both long-dated and real yields.

…but who will buy next year’s glut?

If the issuance profile for 2022/23 is relatively reassuring, the numbers for 2023/24 and beyond reveal the scale of the challenge ahead.

The net cash requirement forecast for next year is £188 billion. On top of that, the Bank of England is set to reduce its Asset Purchase Facility portfolio by £80 billion. That adds up to over a quarter of a trillion pounds that someone outside of the UK public sector needs to buy.

Putting those numbers in context, we can see the risk of the potential gilt supply indigestion problem in the chart below.

Who will buy all the bonds? There is no simple answer to that.

Final thoughts

Jeremy Hunt may have calmed the situation by following through with a well-anticipated fiscal tightening, but the UK is not out of the woods.

Higher interest rates, a cost-of-living crisis and the new era of austerity don’t make for a rosy growth outlook – nor an easy route to complying with Hunt’s own fiscal rules.