Policy errors set Chancellor on course to announce ‘Osborne-level’ spending cuts to balance the books

The Chancellor’s fiscal statement last week and the severe market fall-out from it – including a plunging pound, rising interest rates and emergency intervention from the Bank of England – will force him to make tough policy choices, including big spending cuts, in his promised Medium-Term Fiscal Plan due in less than eight weeks’ time, according to new Resolution Foundation analysis today (Thursday).

Last Friday’s Fiscal Statement – in which the Chancellor announced £45 billion of permanent tax cuts without any details of how they would be paid for – has created significant turmoil in financial markets. Since last Thursday, the pound has fallen by around 3 per cent on the Bank of England’s effective sterling exchange rate.

More importantly, expectations of future interest rates have also climbed by around one percentage point over this period – adding over £1,000 a year to the average mortgage bill, and increasing the Government’s debt interest costs by around £12.5 billion a year by 2026-27.

As well as damaging both family and public finances, the turmoil in financial markets has led the Chancellor to commit to setting out how he will set the public finances on a sustainable footing in a Medium-Term Fiscal Plan to be delivered on 23 November – this time alongside a new economic outlook from the Office for Budget Responsibility (OBR).

The scale of tax cuts and weaker economic outlook will make this a hard task, however. Last week’s Fiscal Statement saw the £30 billion of fiscal headroom inherited from the previous Chancellor blown twice over, and further rate rises have added to the challenge since then. Without the OBR forecasting much faster growth in the years ahead, the Government is likely to need to announce fiscal tightening of between £37-£47 billion in order for debt to be falling by 2026-27.

With the Government refusing to U-turn on tax cuts, this level of fiscal tightening would require announcing spending cuts that are broadly the same or bigger than George Osborne set out in his 2010 Emergency Budget. The painful policy choices that will be considered inside HM Treasury include:

• Cutting public investment back to its 1996-2016 average – saving £25 billion by 2026-27 – but also reducing economic growth in the process.
• Uprating benefits (including the State Pension) by earnings instead of inflation next year – effectively a 4 percentage point real-terms cut. This would raise £11 billion in one year, rising to £20 billion over two years, but would cost a typical low-income working family with two children over £1,000 a year.

To avoid even deeper spending cuts, the Prime Minister will also need to abandon her pledge to increase defence spending to 3 per cent of GDP by 2030. This would cost a further £12 billion a year in 2026-27 (based on it increasing it to 2.3 per cent by 2026-27 en route to the 3 per cent by 2030).

These cuts will come on top of significant reductions in real public service spending due to the Government’s decision to stick to previously announced spending plans for the current spending review period, despite inflation being far higher than expected.

Torsten Bell, Chief Executive of the Resolution Foundation, said:

“Last Friday the UK saw the biggest unforced economic policy error of my lifetime, with a huge package of tax cuts announced against the backdrop of already rising interest rates, and without any explanation of how they would be paid for.

“Lower taxes combined with a loss of market confidence mean rising interest rates, leading to higher mortgages and lower living standards. But looking further ahead they will mean lower spending too.

“Without U-turns on some tax cuts, the Chancellor has eight weeks to decide which unpleasant combination of growth-reducing public investment cuts or income-reducing welfare cuts he is going to announce.

“The UK is not unique in experiencing tough economic times amid rising prices and interest rates. But it has uniquely chosen to make things significantly worse through its own policy choices. The intention may have been to emulate Margaret Thatcher, but the reality may involve looking a lot like George Osborne in the years ahead.”