Higher interest rates, inflation could dent UK government's finances: analysts

London

ECONOMISTS and several Conservative politicians in the United Kingdom are concerned that British Finance Minister Rishi Sunak's latest Budget is proving to be a big gamble on his part.

"The government is expanding the state and raising the tax burden. It's not a route to wealth creation and is reliant on unknown outcomes.

"The scale of spending is formidable," The Times newspaper said in an editorial on Thursday (Oct 28), a day after Sunak announced the Budget.

The UK's Covid-19 vaccination programme, the relaxation of lockdowns and a better than expected economic growth forecast of 6.5 per cent this year encouraged Mr Sunak to embark on a £150 billion (S$278 billion) public spending spree in the remaining three years of the current term of Parliament.

The state's proportion of spending in the economy is 42 per cent of gross domestic product (GDP), while total sovereign borrowing is at 98 per cent of GDP, or £2.37 trillion.

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The fear is that the government will crowd out the private sector and hinder productivity growth, said analysts.

Sunak is already raising business, individual, health and social security taxes, partly to cover projected pandemic borrowings of around £315 billion.

The result is that the UK's tax burden has risen to 36 per cent of GDP, the highest level since the immediate years after World War II.

Moreover, the Office of Budget Responsibility (OBR) predicts that inflation, which was 3.2 per cent in September, will climb to 4.4 per cent in the next year and possibly rise to more than 5 per cent after that.

The worry now is that the Bank of England will be forced to raise interest rates.

Higher interest rates and inflation would dent the government's finances as new borrowings would have to be set at higher yields.

The cost of inflation-linked bonds is set to increase too. Analysts say there is already a squeeze on incomes and higher mortgage rates will not help the situation.

Indeed, recent surveys by YouGov and IHS Market indicate that the ongoing energy crisis in the UK and a sharp increase in food prices have caused a tailback in consumer spending.

"This year has seen the biggest set of tax-raising measures since 1993," said Paul Johnson, director of the Institute of Fiscal Studies.

"The coming year will also be a difficult one for living standards. For example, for middle-earners, rising inflation and tax rises mean their real take-home pay is set to fall."

Neil Shearing, the chief economist of Capital Economics, is more optimistic.

He noted that besides the spending, Sunak also managed to save a "substantial amount".

The savings "hidden in the OBR analysis" could allow Sunak to cut taxes ahead of the next election, he said.

"The overall fiscal judgement is probably the right one from the perspective of the economy."

The OBR expects that pandemic "scarring" will cut potential output by 2 per cent.

Although this is better than the previous prediction of 3 per cent, the OBR said that uncertainty around this judgement remains large.