The British Fiscal Morass and why the October Budget Made it Worse

For the second time in just over two years, Britain has seen government borrowing costs surge and confidence sag in the government's economic strategy. The latest episode has not been as acute as around the time of the Truss/Kwarteng mini-Budget in September 2022, but it is nevertheless still concerning. The 2024 Autumn Budget appears to be responsible for little of the rise in gilt yields seen since that time, with the rise in yields attributable to spillovers from rising US yields. In fact, gilt spreads over Treasuries have narrowed slightly since the 2024 Budget. There are some fundamental challenges with the current UK fiscal situation that sensitises the market to bad fiscal news. These include the poor underlying growth rate, an ageing population, low public sector productivity and gross government debt equivalent to nearly 100 per cent of GDP and a real interest rate on government debt of 2.12 per cent. The Autumn Budget and other measures prioritise public spending, including public pay, and will result in the highest tax burden seen in the United Kingdom. At the same time, it will take resources away from those who save relatively more and redistribute them to those who save relatively little. The effect will bog down growth further and reduce productivity, worsening fiscal prospects. The Chancellor billed the Budget as aimed at national rebuilding, but the OBR expects it to leave little impression on GDP five years out. The OBR shows GDP per head slightly lower than in their March forecast, though it does expect slightly higher GDP in the short run, with the Budget simply shifting resources to the public sector and away from the private sector. Since the October 2024 Budget, the yield on British government bonds (gilts)has risen substantially, leading comparisons to the sharp rise in September 2022. Such comparisons are misplaced, with the 2022 spike in yields being chaotic and idiosyncratic to the UK. The recent rise has been in parallel with higher US Treasury yields and orderly, though market dissatisfaction with the Budget is showing in weaker sterling. Longer–term, the UK budget is on an unsustainable path (as is the US), with demographic and debt dynamics being major contributors. The unsustainable debt profile makes the gilt market vulnerable to adverse shocks. The projections underlying the Budget are too optimistic, with a major source of over–optimism being an assumed acceleration in productivity. Meanwhile, the Budget's stated aim to increase UK investment will fail, because the Budget prioritises consumption and fails to deliver a surplus on the government's current operations.