Grim economic outlook should worry Chancellor more than cost of debt, economists warn Business News

The chancellor should be more worried about the risk that the cost of living crisis will push the UK into recession later this year than about the rising cost of debt, economists warn.

Rishi Sunak faces a trade-off between trying to reduce public debt or easing pressures on households when he delivers his spring statement to the shipping box on Wednesday.

Public sector borrowing was nearly £26bn lower in the year to February, compared to the Office for Budget Responsibility forecast in October. This, combined with a higher-than-expected tax take, gives the chancellor enough fiscal room to cut the cost of living for households, economists and analysts said.

Yet some fear that the Treasury will adjustments to fiscal policy in a context of continued reductions in benefits in real terms and the introduction of an increase in national insurance contributions equivalent to 10% for most employees.

“If you don’t cut taxes and raise benefits, you increase the risk of a recession later this year. It will cause far more harm to the economy and to public finances,” said Julian Jessop, an independent economist and fellow at the Institute of Economic Affairs, a think tank. The Independent.

The Resolution Foundation also warned that the risk of a recession “looms” amid a deepening cost of living crisis.

It comes as a group of international institutions, including the global lender of last resort, the International Monetary Fund, have warned that the high energy costs and wider economic fallout from Russia’s invasion of Ukraine pose risks. for global growth.

“Price shocks will impact around the world, particularly on poor households for whom food and fuel represent a higher proportion of expenditures,” the Washington-based lender said earlier this month. Meanwhile, Fitch Ratings, a credit rating firm, has warned of a deterioration in global growth prospects as inflation returns “with a vengeance”.

Higher inflation can lead to higher interest payments on debt, which is directly linked to measures of price growth in the economy – around a quarter of UK gilts are linked to the retail price index .

Mr Sunak said on Tuesday that with inflation and interest rates on the rise, it is “crucial that we don’t let debt soar and burden future generations with more debt”.

But inflation also has a windfall effect on the public purse, as departmental budgets are set in terms of cash, rather than the pace of prices. Higher nominal GDP growth also translates into higher nominal taxes.

“There are factors that pull both ways with inflation. It costs more money to fund the debt stock, but the tax levies are also going up,” Mr Jessop said. “But at short term, even without the windfall, it makes sense to borrow to withstand the pressure.”

Without a change to the current course of fiscal policy, Mr. Sunak would effectively tighten the public purse strings.

According to economists, a reduction in fuel duties, as Mr Sunak has pointed out, and a slight increase in the threshold for national insurance contributions would do little to remedy the global fuel cost crisis. life.

Although inflation has risen sharply and is expected to remain high, with the Bank of England warning that it could remain above 8% for three months from April, before a higher peak in October, interest rates interest are only returning to their pre-pandemic levels.

That’s important for the three-quarters of the UK’s debt that is not linked to the retail price index, a volatile and imperfect measure of price growth.

“When it comes to debt and debt interest, it’s good not to lose our sense of perspective,” said Isabel Stockton, a research economist at the Institute for Fiscal Studies think tank. “While we certainly need to keep an eye on that, we shouldn’t lose our minds on interest charges just yet.”

Meanwhile, there is a risk that a failure to take more drastic measures could push the UK into recession this autumn, should households drastically cut non-essential spending.

“What we do know is that consumer confidence has fallen,” said Jonathan Portes, professor of economics at King’s College London. The Independent. This may signal cuts in consumer spending – a key driver of UK GDP growth, although it is an imperfect indicator of recession.

Mr Portes warned the spring declaration could be construed as ‘stealth austerity’ if the Chancellor did not use some of the windfall from a higher tax due to inflation, to cushion cuts in real terms of the public sector and the pressure on households.

While inflation is reducing workers’ wages in real terms, even if it has an overall positive effect on public finances, the economy is facing a few difficult months overall with a further rise in energy bills this autumn.

“A lot of risk is on the downside,” Portes said.