Bad economic news is coming thick and fast for Britain. First, long-term gilt yields have risen steadily in recent weeks due to fears of sustained deficits and inflationary pressures. Now, the Government has unexpectedly run a budget deficit of £1.8 billion in July, despite the Office for Budget Responsibility (OBR) forecasting a £500-million surplus only five months ago.
In isolation, a £2.3-billion swing in public finances in one month is nothing to panic about when one considers that the country is projected to run a £115.5 billion budget deficit alone in this financial year. July’s figure is essentially a rounding error. However, this news comes on the back of the OBR’s admission in June that it had underestimated the budget deficit by £60 billion in the previous two financial years.
Some will argue that the wars in Ukraine and Iran are the root cause of unexpected borrowing, but this would be a mistake. War is hardly a rare occurrence. It has become increasingly clear that the “Great Moderation”, those halcyon days of global macroeconomic stability from the fall of the Berlin Wall to the 2008 financial crisis, is never coming back. Any system that relies on such stability returning is doomed to fail. The interconnected global financial system means that there is always the potential for something to go wrong somewhere that affects banks, hedge funds and other institutional investors.
Markets are waking up to the fact that global instability is the new normal, and are pricing government debt accordingly. Ever since the financial crisis, it has been the British strategy to put off hard choices in the hope that the country’s economic fortunes will turn around. They haven’t, and the cost of debt has slowly but surely increased.
To counter the problem of rising debt, Chancellor John Healey is going to have to lay out a credible strategy for the public finances at the next Budget. In broad terms, he has three options. The first is to kick the can down the road and hope that global instability goes away, inflation comes down, and the price of debt falls. This feels the most likely but is fraught with risk, as July’s borrowing figures have shown.
Secondly, he can outline a pathway of tax rises or spending cuts to get the deficit down faster. This feels politically very unlikely, given the high expectations Labour has placed on Healey to fund defense, mass council housebuilding and new infrastructure. Simultaneously, he has to balance the backlash to previous rounds of tax rises and cuts, most notably the Winter Fuel Allowance.
Thirdly, he can stop the Bank of England’s bond sale process, which is pushing up the price of gilts, and find ways to tap British savers to buy British Government debt and reduce the country’s dependence on unpredictable international markets. Part of the reason the country’s debt is so expensive is that nearly a third of UK Government debt is held overseas. This may seem like an easy option, but intervening with the Bank of England risks a big institutional fight that could get nasty in public. This is why chancellors have avoided the option so far. Tapping up British savers means forcing them to put their money in the UK, which will likely generate lower short-term returns than letting them send their money overseas. That is despite Labour’s most recent attempt to direct British pensions into domestic investment, which ultimately failed.
Labour should not panic about one month’s borrowing figures, but this is a shot across the bows. Healey needs to redraw Britain’s economic future and implement a coherent plan for the public finances if he is to have any chance of being more successful than his predecessor.