Chancellor Rishi Sunak has very limited room for manoeuvre in his efforts to restore budgetary discipline before the next general election, especially if interest rates start to rise, the UK fiscal watchdog has warned.
Richard Hughes, head of the Office for Budget Responsibility, said on Monday that Sunak had left himself little wriggle room to meet his new fiscal rules by the end of the parliament.
Sunak announced in his Budget last week that he wanted to balance the budget for day-to-day spending by 2024-25, giving himself £25bn of headroom, and to put debt on a downward path.
But as the Bank of England’s monetary policy committee prepares to meet on Thursday, with a possible interest rate rise on the agenda, Hughes said Sunak had slim headroom against his fiscal rules.
“The headroom he set aside to reach those targets is the second-lowest headroom that any chancellor has had when setting fiscal rules,” Hughes told the House of Commons Treasury select committee.
He said: “Just a 1 per cent interest rate rise could easily wipe out the chancellor’s headroom.” He added that rising interest rates, higher inflation or post-pandemic uncertainty all posed a threat.
The OBR said at last week’s Budget that Sunak had a 55 per cent chance of meeting his fiscal rules, noting that his headroom was low compared with other recent Conservative chancellors.
Sunak acknowledged there were risks he might not comply with the rules, but he told MPs: “I would probably describe it as better than a ‘Cat in hells chance’ — but the numbers are the numbers.”
The chancellor last week set Britain on course to its highest level of sustained public spending since the 1970s, and the largest tax burden since 1950, but claimed he could still balance the current budget by the end of the parliament.
Sunak repeated on Monday his desire to start cutting taxes, saying: “That’s very much my goal and ambition for the rest of the parliament.”
Hughes’ comments reflected the OBR’s belief that it would not take much to go wrong for Sunak’s plans to be blown off course.
Last month Huw Pill, BoE chief economist, said UK inflation was likely to rise “close to or even slightly above 5 per cent” early next year, adding the central bank would have a “live” decision on whether to increase interest rates at its November meeting.
Inflation has been increasing rapidly for much of this year because of the economic recovery from the coronavirus crisis, rising energy prices and global supply chain disruption.
Charlie Bean, a member of the OBR’s budgetary responsibility committee, told MPs that household incomes would not return to pre-pandemic levels until towards the end of 2023.
Hughes warned that public transport may require permanent subsidies if many people continue to work from home. “We don’t know to what extent people are going to start returning to work five days a week,” he said.
Hughes added there was a “significant” economic impact resulting from EU migrants leaving the UK during the pandemic. He said that “EU migrants were particularly favourable to the UK finances in the sense that we tended to not pay for their education”.
Asked about the OBR’s assumption that Brexit would “reduce our long run gross domestic product by around 4 per cent” — twice the damage it assumed would be caused by the pandemic — Sunak was phlegmatic.
“Our trading relationship with the EU has changed post-Brexit, we have a free trade agreement but it’s not exactly the same as before and that means trade patterns take some time to adjust,” he said.
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