The tricky part is that while the OBR’s forecasts, which feed directly into the central bank’s models, cover a five-year horizon, the BOE’s horizon is two years shorter. The government is currently aiming to balance the books over three years, although Hunt will almost certainly extend that. Any spending cuts or tax hikes that Hunt pushes beyond three years are essentially irrelevant to the BOE, as it can’t model the impact on either growth or inflation. So, to affect the BOE’s forecasts, fiscal tightening has to be brought forward to the next two years and be big enough – tens of billions of pounds – to count.
But what makes sense economically and for market credibility can clash with political reality, especially when tax hikes anger an already turbulent Tory party. This is where realpolitik comes in for both Hunt and Prime Minister Rishi Sunak: wise choice of their poison will determine not only the future of this Conservative government, but also how the Tory party is perceived ahead of the next election two years from now.
The ultimate test will be how Thursday’s package affects the value of Sterling and Gilt yields. Heading to the G-20 meetings in Bali earlier this week, Sunak told reporters that putting public finances on a sustainable path was imperative to “meet the expectations of international markets”. The government is well aware that it cannot afford to trigger the collapse of the gilt markets that brought down Liz Truss after just 44 days in office.
Hunt will no doubt use some sleight of hand to delay spending cuts as far as is credible on the OBR’s five-year timeline. Fiscal resistance – misaligning spending increases with inflation and leaving tax thresholds unchanged, causing real incomes to fall – is the stealthiest route. Such opaque measures are far from an honest solution; but promising to be frugal after the next election is not enough.
So there needs to be enough short-term gains from higher tax revenues combined with enough spending restraint to keep the gilt market calm. The BOE must be confident that a tight grip on public finances will complement its efforts to contain double-digit inflation. Only then can it begin to slow the rate hikes.
With the current energy price cap expected to expire in April, the reduced but still significant cost of a tapered replacement targeted at those most in need, which was due to be announced on Thursday, also needs to be factored into consumer price projections. As Bloomberg Economics’ Ana Andrade and Dan Hanson put it this week, “Hunt has a bigger say in inflation in 2023 than the BOE.”
But Hunt will also want an opportunity to offer some relief from the relentless bang of pre-election austerity. It will take some ingenuity not to be too “obvious” to this week’s fiscal tightening, as Hunt has repeatedly warned. He has certainly prepared the ground for everyone to pay more taxes, and in a variety of ways.
The gilt market will closely monitor government borrowing needs for the remainder of this fiscal year. There may be a small reduction in net cash requirements, allowing fewer gilts to be sold by April. However, Hunt could choose not to ease the debt sales knowing the need will be far greater next year. A Bloomberg survey of five gilt traders revealed an average expectation of £250bn issuance in the next financial year; Additionally, the BOE is expected to sell around £50bn of its QE holdings, with a similar amount not reinvested at maturity. Over the longer term, the OBR’s forecasts will set the tone for how bond markets cope with increased supply.
The more Hunt can do now to tighten fiscal stance, the less the BOE has to do on the monetary side. Unfortunately, too much fiscal strain will plunge the economy into a worse recession than is already likely, weakening the pound and deepening the hole the government is trying to emerge from. Closing the fiscal gap without hurting near-term growth while ramping up inflation will not be easy. But having the government and central bank on the same page, under the scrutiny of the independent OBR watchdog, would be a good start.
More from the Bloomberg Opinion:
• Will Sunak test the love of Britain’s top 1%?: Therese Raphael
• The cost of living crisis is a perennial concern for UK consumers: Andrea Felsted
• British families hit by camouflage taxes: Stuart Trow
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Markets Strategist at Haitong Securities in London.
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