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The UK economy is in a “terrible fiscal squeeze” as it heads towards recession and has no scope for tax cuts or increases in government spending to stimulate the economy, according to an influential group of economists.
The Institute for Fiscal Studies (IFS) warned that the UK will slip into a “moderate” recession in the first half of 2024 as the struggle for growth continues while borrowing costs remain high.
The Bank of England’s chief economist warned there was still “work to be done” to bring inflation back under control in the UK – a hint that key interest rates could rise again.
The IFS, in its assessment of the country’s public finances ahead of Chancellor Jeremy Hunt’s autumn statement, said there was little scope for the tax cuts wanted by Tory MPs “in the foreseeable future”.
Based on analysis by Citi, the IFS report warned that the UK would enter a recession in early 2024 that would last nine months. It also predicted that gross domestic product (GDP) would contract by 0.7 percent next year.
“We are in a terrible budgetary bind,” said Paul Johnson, the IFS director. “The price of our high debt levels, failure to stimulate growth and high borrowing costs will likely be a long period of high taxes and tight spending.”
The IFS said there was no scope for tax cuts or spending increases, although a six-year freeze on income tax thresholds would mean an extra £52 billion a year until 2027 – equivalent to a 6p rise in the basic and higher income tax rate.
The amount raised through the “fiscal drag” process – which pushes people into higher income tax brackets when wages rise – was “extraordinary”, said Paul Johnson, director of the IFS.
Rishi Sunak’s government could come under pressure to increase public spending more than planned, the IFS has warned, as it provided a stark assessment of the situation facing a Labor government if it wins the 2024 general election.
Persevere: Sunak and Hunt have warned that the temptation to cut taxes must be resisted
(Downing Street)
Beyond March 2025, there will likely be real cuts to current budgets for many government departments and falling spending on investment in public services, the report said. This comes despite growing pressure to improve services such as the NHS and commit to spending in areas such as defense and childcare.
National debt is also expected to be around £20 billion lower this year than the Office for Budget Responsibility (OBR) forecast in March. But debt has soared as borrowing costs have risen and inflation remains above target.
Better news for the government is that British inflation is expected to fall to around 4.3 percent by the end of the year, according to the consumer price index – meaning Mr Sunak would make good on his promise to halve inflation by the end of December.
The IFS said interest rates will remain above 5 percent until mid-2024, when the Bank of England could begin cutting rates steadily. But the bank faces its own challenge: reducing inflation while avoiding a deeper recession that could be made worse by higher interest rates.
“The Monetary Policy Committee may want to wait for clear evidence of disinflation before considering rate cuts. But by then it may be too late and the result could be a deep recession,” the IFS said.
The central bank’s chief economist Huw Pill said on Monday there was still “work to be done” to combat inflation, suggesting the key interest rate could rise again from its current level of 5.25 percent.
“We still have a lot to do to get back [the inflation target of 2 per cent]”,” he said. “And we probably still have some work to do to make sure that we do this in a way that is sustainable over time when we get back to 2 percent.”
Mr Pill – who said last week that the question of whether the Bank of England needs to raise interest rates further was “very balanced” – said it was important “that we do not prematurely declare victory”.
Benjamin Nabarro, chief UK economist at Citi, said: “The lesson of the 1970s was to keep interest rates low until you can see the ‘whites of the eyes’ of disinflation.” In a highly financialised, debt-driven economy “That may only be half the story.”
The government said it is on track to reduce debt and will not be deterred by changes in economic growth, inflation and interest rates. “To secure our public finances, we must stick to our plan, which is on track to halve inflation, reduce waste in the public sector and reduce debt.”
Mr Hunt is expected to deliver the 2023 Autumn Statement on November 22, along with an economic and financial forecast prepared by the OBR.
In a bleak assessment on Friday, Mr Hunt warned that he was “preparing for the worst” ahead of his autumn budget as the Israel-Hamas conflict and the ongoing war in Ukraine weigh on the global economy.
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