Healey looks for bigger buffer as he prepares his first b…

It’s that time of year again. The kids are back at school, the MPs are back in parliament, preparations for the autumn budget are in full swing and the Office for Budget Responsibility (OBR) will be handing its first set of economic forecasts to the Treasury some time around now.

Since the last set of forecasts were produced in the spring, it’s not all been bad news. The UK economy has grown more quickly than expected, so much so that it’s been the fastest growing in the G7 over the first half of this year. This is underpinned by growing signs of a reassuring uptick in productivity growth (though economists aren’t yet done arguing about whether or not it’s real, let alone agreed upon what’s driving it).

The stock market is doing well, consumer confidence hit a two-year high in August, and the Confederation of British Industry (CBI) reckons that pessimism among its members is fading. And, while unemployment is higher than when Labour took office, it’s running below where the OBR expected it would be. There is a positive story to be told here.

Unfortunately, it won’t all be sunshine and rainbows when John Healey delivers his first budget on 28 October.

Rachel Reeves left John Healey with a £24bn margin against the fiscal rule requiring the government to cover all day-to-day spending out of tax revenues. Crucially, that estimate was produced before the US and Israel attacked Iran, before the resulting spike in energy prices, and before the recent global bond sell-off pushed government borrowing costs to multi-decade highs. The yield on a 20-year UK government bond climbed as high as 5.9% last week, whereas the OBR’s March forecast was predicated on a rate of 5.1% this quarter. For reference, it was below 1% during the pandemic.

Bond yields have been rising across the developed world in recent weeks, and are primarily being driven upwards by global events rather than UK-specific factors. The fiscal consequences are still the same: the government’s debt interest bill is going up.

Combine that with various unfunded spending commitments and the likelihood of a lower immigration forecast, and that £24bn number has probably halved. Precise estimates vary, but Healey probably needs to find £10bn to £15bn in tax rises or spending cuts if he wants to restore the so-called “fiscal headroom” to its previous level as a buffer against economic uncertainty.

That’s before finding any cash for a new cost of living package (which could cost several billion, even if targeted at the most needy), a plan to get defence spending to 3% of GDP by 2030 (around £10bn), or any of the other expensive-sounding things the new prime minister has expressed an interest in.

All in all, Healey finds himself in a similar predicament as Reeves this time last year: the fiscal situation is tight, he needs to find cash from somewhere, and he’s trapped between his fiscal rules and Labour’s unwise manifesto promises on tax. There are five lessons he might draw from his predecessor’s experience.

First, he should build in a sizeable buffer against his fiscal rules. To do otherwise – as Reeves did early in her tenure – would leave him completely at the behest of global events, and would fuel damaging speculation about tax rises every time Donald Trump sends bond yields higher. Presenting a credible plan to bring down borrowing faster could actually lower bond yields – reducing the government’s debt interest bill and the interest rate facing mortgagors in the process.

Second, if he’s going to look for savings in the welfare bill, they shouldn’t be announced in isolation (à la winter fuel payment) or without having laid the political groundwork first (à la disability benefit reform). If that means waiting until next year, wait until next year.

Third, going for a “smorgasbord” of small tax rises could come back to bite him, especially if it means damaging business confidence or incentives to invest. In any case, the easier, manifesto-friendly revenue raising options have now been exhausted.

And, looking beyond the immediate fiscal repair job, if the government is serious about closing the gap between its rhetoric and its actual policy on defence spending (Healey did, after all, previously resign over the issue), there is no credible route to doing so that doesn’t involve most people paying a bit more tax. That means increasing something like the basic rate of income tax. As the Resolution Foundation noted last week, where the UK stands out internationally is the unusually low rates of tax levied on average earners.

Fourth, part of the reason the UK government pays a premium to borrow relates to its record on inflation, as well as on debt. UK consumer prices are 16% higher than they would have been had the Bank of England’s 2% target been consistently met over the past decade. The equivalent figure for the Euro area is 9%. As chancellor, Reeves’s large increase in employer national insurance pushed up labour costs and, in turn, pushed up prices. Healey would be well-advised to consider the inflationary impact of his budget choices, as well as the fiscal ones.

Fifth and finally, having a positive narrative matters. Even for the financial markets, vibes matter. Healey is giving a speech on Monday which is expected to be focused on the importance of place-based growth. He should make it an optimistic one.

Photograph by Matthew Horwood/Getty Images