Slowing Inflation Provides Glimmer of Hope for UK Budget Amid Rising Borrowing

In November alone, the deficit hit £14.3 billion, surpassing economists' expectations, which had projected a shortfall of £12.9 billion.

Official data released on Thursday revealed a worsening budget situation for British Prime Minister Rishi Sunak.

However, there is a glimmer of hope as slowing inflation may reduce the debt interest burden, providing some leeway for potential pre-election tax cuts.

The Office for National Statistics reported that public sector net borrowing, excluding state-owned banks, had reached £116.4 billion ($147 billion) in the current financial year, marking a £24.4 billion increase compared to the same period last year (April to November).

In November alone, the deficit hit £14.3 billion, surpassing economists’ expectations, which had projected a shortfall of £12.9 billion.

Additionally, the statistics office revised upward the borrowing figures for each of the preceding seven months by a total of £3.7 billion.

The surge in British borrowing has been a result of government support during the COVID-19 pandemic and the need for substantial aid to households and businesses to counter the impact of soaring energy prices in 2022.

These figures serve as a stark reminder of the limited fiscal headroom available to Sunak, particularly as he seeks to implement tax cuts ahead of expected elections next year.

Recent opinion polls have indicated that Sunak’s Conservative Party is trailing the opposition Labour Party.

“Fiscal headroom” refers to the margin that Britain’s finance minister, Jeremy Hunt, has to expand fiscal policies such as tax cuts or spending increases before hitting rules designed to control borrowing and debt levels.

The Office for Budget Responsibility estimated the fiscal headroom at £13 billion in November when Hunt introduced tax cuts for workers and businesses while also tightening spending on public services.

However, the cooling inflation, which recently dropped to a 3.9% annual rate (the lowest since September 2021), is expected to expand Hunt’s fiscal headroom by reducing Britain’s debt interest payments in the coming months.

Economist Samuel Tombs from Pantheon Macroeconomics suggests that Hunt could potentially have around £25 billion of fiscal headroom by early 2024.

Despite this increased flexibility, Tombs believes Hunt will remain relatively restrained with pre-election spending, citing how bond prices fell shortly after the announcement of tax cuts in November.

Additionally, the government’s interest rate bill, although historically high, has fallen by 15% to £61 billion in the April-November period due to slowing inflation, alleviating the burden from inflation-linked bonds.

Thursday’s data also highlighted the impact of inflation and rising wages on tax receipts, with income tax, corporation tax, and value-added tax all seeing an 8-10% increase in receipts in the April-November period compared to the previous year.

Spending on benefits and pensions rose by 12% to £195 billion during the current financial year, reflecting a significant inflation-adjusted increase in welfare.

Despite these challenges, public sector net debt, excluding state-owned banks, remains at £2.67 trillion, equivalent to 97.5% of economic output. Sunak has pledged to reduce this debt burden.