The UK Autumn Statement preview: shoring up revenues, scaling back spending

The UK Budget due out on 17 November is expected to bring significant fiscal tightening in a bid to restore the government’s financial credibility and limit rising rates. Here’s what our specialists think it will contain and what that could mean for markets and the economy.

What has changed since October 31st?

Apart from fewer Halloween costumes or trick-or-treaters roaming about, very little. The UK’s risk premium had already retreated as the prospect of a tighter fiscal policy was baked in. Sterling had recovered from the drop experienced in late September, meaning the inflationary impulse from that event is less than anticipated at that point. 

The Bank of England increased Bank Rate to 3% from 2.25% on 3 November and pushed back against expectations of markets anticipating a 5.25%, with its forecasts suggesting rates at those levels would be more than what’s necessary to bring inflation back to target. Market pricing now indicates a peak of 4.75%, and that’s some way below the the 6% level that was being priced following the mini budget.

How big is the UK’s ‘fiscal hole’?

In a word: large. Reports suggest that UK Chancellor Jeremy Hunt could be seeking to fill as much as £50 billion as he tries to stabilise the public finances.

What everyone wants to know is how. The answer lies in a combination of spending cuts and tax rises to get debt falling as a proportion of Gross Domestic Product (GDP) over the medium term, which is by the fifth year of the forecast period. Budgetary tightening on this scale equates to around 2% of GDP. That would have been the economy’s growth figure in a typical year not so long ago, so it’s significant. 

Treasury sources cited in the media have suggested the adjustment will be split roughly evenly between tax rises and spending cuts, in contrast to the post-Global Financial Crisis fiscal tightening – which was skewed much more towards spending restraint.

What kinds of revenue-raising measures can we expect?

To fill the fiscal hole, both the Chancellor Jeremy Hunt and PM Sunak have said that everybody would have to pay more tax. Measures of the stealth variety are reportedly under consideration; that means freezing tax thresholds so more earners are dragged into higher rate brackets. Remember, pay growth may be running way behind price rises, but at 6% in the three months to August, earnings are growing at around twice the pace they were in the year before covid. Even if it slows amidst a broader slowing in the economy, it looks set to remain at a healthy clip.

Among the other list of measures that could make an appearance:

  • Cut public spending; limiting public sector pay rises 
  • Cut/update benefits/pensions in line with earning instead not inflation 
  • Freeze Foreign aid
  • Impose higher windfall tax on energy profits
  • Cut spending on capital projects 
  • Increase VAT
  • Restore National Insurance Contributions (NIC) increase

The exact extent and timing of fiscal consolidation remain uncertain. With a General Election perhaps most likely in autumn 2024, some of the more painful fiscal tightening could be kicked down the road.

The UK economy will contract over the next two years, but the composition of fiscal support will impact the pace of the slowdown

The composition of this fiscal consolidation is unknown. But it matters in assessing its economic impact. Press reports suggest that tax rises will account for about half of this consolidation while the other half will be raised from other government spending cuts. 

Even before these fiscal measures the economy faced a challenging backdrop. Growth was forecast to be very low through 2023 as the lagged effect of higher rates and the impact of higher energy prices raise production costs and sap broader global economic momentum. 

The Office for Budget Responsibility (OBR) estimates that these measures would depress GDP by 0.25% by 2023-24 and 0.50% in 2024-25. This builds on the modest fiscal squeeze planned in the March 2022 Budget. 

Regarding the impact on inflation, the Chancellor also has signalled that the previously announced Energy Price Guarantee will be scaled back and reformed from April. While there is a lot of uncertainty, that could lead to a higher rate of inflation than otherwise would have been the case. 

Overall, we expect the OBR to revise down its forecasts for the UK economy to reflect the general deterioration in global economic momentum and the impact of monetary policy tightening by the Bank of England. We now expect the UK economy to contract by 1.2% in 2023 and another 0.4% in 2024.

What does it mean for Bank of England?

The latest Monetary Policy Committee (MPC) projections did not include the looming fiscal consolidation. The scale, timing and to a lesser extent the composition of that package of spending cuts and tax rises could have a material impact on how far the MPC lifts rates. 

All else being equal, tighter fiscal policy requires looser monetary policy. Given the scale of fiscal tightening and deteriorating economic outlook it will give the committee reason to slow the pace of rate hikes further ahead and / or lower the peak in rates.

Government borrowing will rise sharply

We expect the Autumn Statement to lead to significant upwards revisions to public sector borrowing and debt projections relative to the Office for Budget Responsibility’s (OBR) March 2022 forecast. 

For fiscal year 2022-23, we forecast that the Central Government Net Cash Requirement (CGNCR) – the borrowing aggregate which underpins gilt issuance – to rise to £158 billion – well above the £94 billion that was forecast in March but a little below the £167 billion expected after the announcement of previous chancellor Kwasi Kwarteng’s Growth Plan on 23 September. This slight drop is because monthly borrowing has been slightly lower than expected and fiscal policy loosening has been scaled back.

We do not yet know if the OBR will include estimates of energy costs in its forecasts as there is, as it stands, no detail about the government’s policy beyond April 2023 other than its intention to reduce the cost of these measures by targeting support at those most in need.

Gilt supply and yields will increase, with 10-year notes hitting 4.3% by end of Q1 2023

Ten-year gilt yields are now around 100 basis points off their highs, with markets taking comfort from the abandonment of the Truss government’s tax policies. But to assume that these political changes will reverse the increase in gilt supply would be wrong. While there are still question marks over funding requirements for next year, the broader trend in public borrowing is clear: gross gilt issuance is set to increase significantly, and the BoE will not help to absorb this additional supply.

If we subtract redemptions and the Bank of England’s Asset Purchase Facility from gross issuance figures, that leaves net issuance of £111 billion for the private sector and overseas investors to absorb this fiscal year and £260 billion next. For comparison, the equivalent yearly net average between fiscal years 2012 and 2021 was just £35 billion. In a low-growth, high-inflation world, it’s hard to see demand for gilts keeping up with this kind of supply.

Taking all of this into account, we believe yields should be higher than they are at present despite the changes in government and policy. Our target is for 10-year gilt yields to hit 4.3% by year-end.

Get in touch

To learn more about the latest trends shaping the UK economy and how they could affect your business, get in touch with your NatWest representative or contact our Corporates team here.

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