MNI INTERVIEW: Little Scope For Further UK Fiscal Loosening

There is little chance of further UK fiscal loosening despite unrest within the governing Labour party and the prospect of an energy bill support package, a former Chief of Staff at official fiscal watchdog the Office for Budget Responsibility told MNI.

"The scope for loosening further is quite limited anyway, because the binding constraint will become the market reaction," and all plausible Labour leaders "recognise that there is not a huge amount of scope for more borrowing," Andy King said in an interview.

"I see there's some debate now about whether the fiscal target should be permanently loosened in response to this hopefully temporary energy price shock. I think that would be a mistake," he said. "My read of the situation is that minor changes are more likely than major. If the current prime minister, chancellor team is still in position, then I think it's very unlikely that they change the fiscal rules.” (See MNI INTERVIEW: BOE Can Look Through Starmer's Woes - Saunders)

With public debt at 100% of GDP, even talk of relaxing fiscal constraints has tended to feed into higher bond yields, with a material impact on public spending projections, King noted.

ENERGY SUPPORT PACKAGE

"I feel for my former colleagues in the OBR and Treasury as they face yet another serious economic shock...the outcome of which is just unknowable at the moment," he said.

Since the outbreak of the Iran war, "interest rate curves suggest a significant hit to fiscal headroom. If the shock persists long enough that the government feels it has to step in and provide more widespread support to households with their energy bills, then there's potentially a step up in the amount of debt if a debt-financed support package goes through," he said.

In their favour, "policymakers have time to think, and they also have the experience of 2022 to look back on, King noted," as household gas consumption "won't really ramp up until the winter" and household energy prices are frozen until July. (See MNI INTERVIEW:  UK Energy Price Aid Could Be Cheaper This Time)

"You can see from the statements being made by the chancellor, by the prime minister, that they are thinking hard about how and when to deliver support so that it is not as expensive as last time, it is better targeted, they get the timing right, they get the quantum right." (See MNI INTERVIEW: UK Energy Relief Could Extend Beyond Shock)

"It's just close to impossible to determine how long this is going to last, and that is the most important variable in determining what the right policy response is." 

BACKLOADING

The government already faces major challenges to meet its fiscal commitments, according to King, even after Chancellor of the Exchequer Rachel Reeves increased the buffer against her fiscal rules to GBP22 billion in November, implying a 59% probability of meeting them according to the OBR, and then further to GBP24 billion on March 3.

"We are still in a world where challenges are being left for the future, and some aspects of tax and energy policy have dates attached that don't look politically realistic,” he said, 

"There are aspects of the public spending plans, particularly defence spending commitments, that have not been inked in yet, that make the next spending review next summer for the period extending beyond the election... look incredibly challenging,” King said, noting the promised uplift in defence spending to 3% of GDP by 2034.

Other measures kick in close to the election including pre-existing energy bill support.

"On the capital side, there is a little bit more space because of the way the fiscal rules work, so that the capital budget overall is growing in a way that allows some of these commitments to be made within the envelope.”

Some of the back loading of tax rises in the budget last year was “credible”, King said, adding also that "Freezing tax thresholds for an extra couple of years has been a reliable way of bringing in money, and you'd expect it to continue to be," he said, "partly because it's strangely invisible to people."

In the March forecast round, fiscal headroom increased to 0.6% of GDP, though this was derived from market determinants taken before the war began.