The tricky thing is that the OBR’s forecast, which feeds directly into the central bank’s models, looks out over five years, but the BOE’s horizon is two years shorter. The government currently aims to balance the books in three years, although Hunt will almost certainly extend this. Any spending cuts or tax increases that Hunt pushes out over three years are basically irrelevant to the BOE, since it can’t model the effects of growth or inflation. So in order to influence the BOE’s projection, fiscal tightening must be front-loaded over the next two years and needs to be calculated on a substantial scale – tens of billions of pounds.
But what makes sense economically and for market credibility may be at odds with political reality, especially if the tax gives an already turbulent Tory party a fight. For both Hunt and Prime Minister Rishi Sunak, this is realpolitik: choosing their poison wisely will determine not just this Conservative government, but how the Tory Party fares in the next election in two years.
Thursday’s package will be the final test of how it affects sterling and gilt yield prices. On his way to the G-20 meetings in Bali, Sunak told reporters earlier this week that public finances needed to be put on a sustainable path to “meet the expectations of international markets.” The government is well aware that the gilt market slump that brought Liz Truss into office 44 days ago cannot accelerate.
Hunt will use some of his hand to push out spending cuts as long as he is faithful to the OBR’s five-year timeline. Fiscal drag – inflation that doesn’t match spending increases, and real income falls by leaving the tax threshold unchanged – is the fastest way to go. Such opaque measures are far from honest solutions; But the promise to be frugal after the next election will not hold.
So a substantial increase in short-term revenue from higher taxes is needed to keep the gilt market calm, along with sufficient spending restraint. The BOE needs to feel confident that a firm grip on public finances will complement its efforts to stave off double-digit inflation. Only then will the rate of interest increase ease.
With the current energy-price cap scheduled to expire in April, the lower but still substantial cost of a tapered replacement focused on the most needy, which should be announced on Thursday, will also factor into consumer price forecasts. “Hunt has a bigger say on 2023 inflation than the BoE,” Bloomberg Economics’ Ana Andrade and Dan Hansen said this week.
But Hunt also wants an opportunity to provide some respite from the relentless drumbeat of austerity ahead of the election. As Hunt has repeatedly warned, it will take some finesse not to get too “eye-watering” with this week’s fiscal tightening. He certainly laid the groundwork that everyone would pay more taxes, and in more ways than one.
The gilt market is closely watching the government’s borrowing requirements for the remainder of this financial year. There may be some small reduction in net cash requirements, allowing fewer gilts to be sold through April. However, Hunt may choose not to facilitate debt sales, knowing that next year’s requirements will be much higher. A Bloomberg survey of five gilt dealers showed an average expectation of issuing £250bn in the next financial year; On top of this, the BOE is expected to sell around £50 billion of its QE stock, with the same amount not being reinvested at maturity. The OBR’s forecast will set the longer-term tone for how bond markets cope with rising supply.
As much as Hunt can do now to strengthen the fiscal position, the BOE will have to do less on the monetary side. Unfortunately, taking too much financial pain forward will plunge the economy into a worse recession than is already possible, weakening the pound and deepening the gap the government is trying to escape. It will not be easy to close the fiscal gap without harming near-term growth as inflation needs to be contained. But getting the government and the central bank on the same page, under the careful scrutiny of the independent OBR watchdog, would be a good place to start.
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This column does not necessarily reflect the views of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Prior to this, he was Chief Market Strategist at London-based Haitong Securities.
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