United Kingdom: New chancellor performs fiscal policy U-turn; Liz Truss resigns
Jeremy Hunt replaced Kwasi Kwarteng as chancellor and announced the reversal of most of Kwarteng’s tax cuts.
The fiscal deficit and public debt should decrease as a result, although headline inflation could rise.
Our panelists have contrasting views on the GDP impact.
Liz Truss subsequently resigned as prime minister; her replacement will likely stick to Hunt’s more austere fiscal roadmap.
What happened: Kwasi Kwarteng was fired as chancellor in mid-October, weeks after announcing tax cuts worth around GBP 45 billion. He was replaced by experienced Cabinet Minister Jeremy Hunt. Hunt has since cancelled roughly GBP 32 billion of the planned tax cuts. He also stated that the cap on energy bills—which was due to last until October 2024—will be made more targeted from April 2023.
Further austerity measures are set to come in the 31 October Medium-Term Fiscal Plan (MTFP), with changes likely to both taxes and spending. However, this date could be pushed back by Liz Truss’ replacement—who will be named by 28 October—to give time for them to leave their mark on the plans. Regardless of who becomes the next PM, or whether Hunt remains as chancellor, his more cautious fiscal approach is set to remain in order to placate investors and tame borrowing costs.
The impact on the fiscal stance: Recent announcements, together with the MTFP, should lead to a substantially smaller fiscal deficit than under Kwarteng’s fiscal plans. Hunt has pledged “to get [public] debt falling as a share of the economy over the medium term.” Moreover, borrowing costs have pulled back in recent days, and will likely fall further if the MTFP convinces markets of the government’s commitment to fiscal prudence. Lower borrowing costs would help narrow the deficit.
The impact on monetary indicators: Fiscal austerity should limit core inflation, and thus the rate hikes required of the Bank of England. However, tweaks to the energy price cap from next April could increase headline inflation in 2023.
On inflation, ING’s James Smith said:
“The Chancellor’s decision to make the government’s energy price support more targeted could see most consumers switch back to the Ofgem-regulated price from April. We still need to see how this is going to work in practice, but such a scenario could add between 2-3pp to headline inflation from April onwards.”
On monetary policy, economists at Nomura said:
“The fact that we’re going from fiscal loosening to tightening […] means that we’re more comfortable in our view that the BoE hikes by “only” 75bp on 3 November. […] The need for a significant upcoming monetary response was conditioned in part on the government’s fiscal largesse – now a lot of that has been removed the Bank should be less willing to deliver an outsized hike in rates.”
The impact on GDP growth: Compared to previous plans, higher taxes, presumably lower spending—the MTFP will provide more detail on spending—and higher energy bills from next April will all weigh on demand. That said, these factors will be at least partly counterbalanced by looser financial conditions. Indeed, there is some discrepancy among our panelists as to the overall impact of the new fiscal stance on the economy.
Analysts at Goldman Sachs said:
“We recently downgraded our UK growth outlook meaningfully on the back of earlier fiscal policy reversals, weaker growth momentum and the notable tightening in financial conditions. But we see additional downside risks to growth on the back of [Hunt’s] announcements.”
In contrast, Berenberg’s Kallum Pickering commented:
“In the wake of the financial market turmoil of the mini-budget, we lowered our forecasts for real GDP and inflation on the basis that tighter financial conditions would outweigh any positive benefits to demand from lower taxes. Following the big fiscal U-turn […], the situation is likely to be less bad than feared. […] We now expect the economy to contract by 1.3% instead of 1.6% in 2023.”