Rachel Reeves has been warned again that the slim headroom against her ‘ironclad’ fiscal rule could be wiped out if growth prospects worsen. The Organisation for Economic Co-operation and Development (OECD) said in its latest economic outlook for the UK that ‘very thin fiscal buffers could be insufficient to provide adequate support without breaching the fiscal rules in the event of renewed adverse shocks’. The OECD also downgraded Britain’s growth forecast. It predicted the economy will grow by 1.3 per cent in 2025 and then just 1 per cent next year – a fall from their previous forecast of 1.4 and 1.2 per cent. The OECD said this downgrade was caused by continuing uncertainty surrounding trade caused by Donald Trump’s tariffs and high interest rates.
The figures pile further pressure on the Chancellor as she prepares for her spending review next week. ‘Fiscal prudence is required’, the OECD said, making it clear that real-term spending cuts in unprotected departments need to be substantial in order to balance the books. The alternative is serious hikes in personal taxes in the Autumn, something the government has repeatedly ruled out but many across Whitehall see as inevitable in the coming years.
Reeves does have one get out though: to follow the advice she received from the International Monetary Fund last week. The IMF suggested that Reeves could loosen her fiscal rules by only assessing headroom once a year, or by changing the requirement for corrective action so that she doesn’t have to make small breaches to the rules caused by fluctuating forecasts.
If Reeves were to do that the conventional wisdom is that the bond vigilantes would lose the plot and we could return to the scenes witnessed after Liz Truss’s budget. It’s certainly true that cost of borrowing is on the rise as bond yields increase despite falling interest rates – something the OECD finds unusual enough to point out.
But speak to bond traders in the City and the truth is they don’t care one jot about the fiscal rules. They care about stability and long-term commitments to fiscal prudence. They want to see economic leaders with the political will to reign in Britain’s ballooning state and return us to proper growth. There is a world in which a rigorous plan for reform, that took in those points, could do away with the fiscal rules in order to meet investment goals and move us away from the feeling of daily fiscal crisis. But it could only come for a Chancellor who has won the respect of the City and Rachel Reeves probably isn’t that.
Comments