Paring back investment may prove the least politically painful way to make the sums add up
The short-lived era of Trussonomics came to a sudden and undignified end yesterday as the prime minister’s new chancellor junked almost the entirety of her plan for “growth, growth, growth” and instead set out his intention to stabilise the UK economy.
While embarrassing for Truss, the statement made by Jeremy Hunt appeared to achieve its stated aim, as the pound surged more than 2% against the dollar and UK borrowing costs tumbled, with the yield rate down by 40 basis points.
Paul Johnson, the director of the Institute for Fiscal Studies (IFS), said the announcement was “a step in the right direction”, but as Hunt himself admitted, telling the public to expect “more difficult decisions on both tax and spending”, the government still has work to do to establish its fiscal credibility.
All government departments have been asked to find efficiencies, according to the chancellor, with Treasury leaks over the weekend indicating that the Office for Budget Responsibility was projecting a medium-term hole in the public finances of roughly £72bn.
The scrapped tax cuts will raise £32bn for the Treasury, according to Hunt, leaving a £40bn hole to fill if the government wants to achieve its aim of getting debt falling as a share of GDP by 2026-27.
A favourable market reaction to Hunt’s frugality could cover some of this gap – a 1% decline in gilt yields and interest rates would take off around £10bn. The IFS estimates that reduced borrowing costs, lower than expected interest rates and a revised growth forecast would leave the chancellor with roughly £20bn to cut.
There are several options for how to achieve this, including U-turns on what remains of Kwarteng’s mini-budget. Allowing national insurance to rise would save £15.3bn, while cancelling the cut to stamp duty would free up £1.7bn.
Noble Francis, economics director at the Construction Products Association, told Building it was “difficult to see further U-turns”, given the government’s focus on growth, the predicted recession and the prospect of an election in two years.
Indexing working age benefits to earnings instead of inflation (£13bn) has been much discussed in recent weeks, but the optics of cutting benefits in a cost of living crisis while lifting bankers’ bonus cap may render this too politically difficult.
Mike Brewer, chief economist at the Resolution Foundation, said last week that cuts to benefits or public services were unlikely to get through parliament.
Responding to a question from former shadow chancellor John McDonnell in the Commons yesterday, Hunt said he could not make any assurance that benefits would be uprated in line with inflation, but hinted that he was minded to do so, referring to an earlier comment stressing his “compassionate conservative” values.
The alternatives are widespread austerity across Whitehall, which could offer savings of tens of billions, or reducing public investment – cutting this by a third to 2% could save £14bn.
“That may be the least politically painful way to make the sums add up in two weeks’ time, but it’s would also be the most-growth sapping,” said Brewer.
While such an approach would directly contradict the government’s stated commitment to growth, recent weeks have shown that such a volte-face cannot be ruled out.
The constant uncertainty over policy during a period in which the economy is slowing is poor government and bad policy making
Noble Francis, Construction Products Association
It will be interesting to see what role the chancellor’s new economic advisory council – announced in his statement to the House of Commons but accidentally leaked beforehand when photographs of briefing documents were posted to the Treasury’s Flickr page – will play in determining which of these options are taken.
Four independent experts have so far been announced as having been appointed to the council: Karen Ward, managing director at JP Morgan Asset Management; Dr Sushil Wadhwani is the chief investment officer at private equity fund QMAW; Gertjan Vlieghe, former Bank of England policymaker and chief economist at US hedge fund Element Capital; and Rupert Harrison, former chief of staff to George Osborne when he was chancellor.
While financial markets appear to have calmed, the coming weeks will likely be nervy for industry, with speculation over where cuts will fall sure to weaken business confidence.
“The constant uncertainty over policy during a period in which the economy is slowing is poor government and bad policy making,” said Francis.
“It puts off firms looking to invest, whether it is in skills and product manufacturing capacity as well as developers looking to make large upfront investments in commercial, industrial or residential construction.”