Chancellor of the Exchequer Rishi Sunak has a tough job on his hands when he delivers his autumn budget on Wednesday.
Positive signs such as a dip in government borrowing in September and an unexpected increase in business activity in October may indicate Britain’s post-Covid recovery is on track.
As the fiscal and monetary double act that saw Britain through the pandemic comes to an end, Mr Sunak must go it alone with dwindling resources at his disposal to bolster the recovery.
Rishi Sunak will hail his Budget as ushering in a “new economy” after the coronavirus pandemic as he confirms billions of pounds of funding for the NHS and wage rises for millions of workers.
The Chancellor is to bill his tax and spending plans on Wednesday as preparing an “economy fit for a new age of optimism” as the nation recovers from the hardship of Covid-19.
So could Mr Sunak’s autumn budget end up hampering Britain’s recovery from the Covid-19 pandemic at the most delicate stage of the process?
“Absolutely, yes,” Stuart Cole, chief macroeconomist at brokerage Equiti Capital told The National. “Politicians are very good at making problems worse.”
September’s public finances data allowed Mr Sunak to boast that the recovery is well under way, with more employees on payrolls than ever and the fastest forecast growth in the G7 this year.
However, he was not immune to the challenges ahead, pledging to continue to support public services, businesses and jobs “while keeping our public finances fit for the future”.
Mr Cole said there is already evidence of the UK recovery slowing, with gross domestic product growth of just 0.4 per cent in August, with a reduction in consumer spending a key driver behind this.
Add in rising prices, rising Covid-19 cases, the risks of new lockdown measures being imposed and the tax increases already in the pipeline such as an increase to National Insurance and corporation tax, and any decision by Mr Sunak to increase the tax burden “will only weaken consumer confidence and see many consumers cut back on spending”.
“The big risk is that Mr Sunak announces some new spending plans, but attempts to keep the markets on side by simultaneously increasing the tax burden, the impact of which will combine with rising interest rates and further slow the recovery,” said Mr Cole.
"If he gets this balancing act wrong, then we could see the recovery stalling.”
During his 20 months in office, Mr Sunak has helped to bring about an unprecedented stimulus programme involving both the Treasury and the Bank of England.
The two came together to unleash hundreds of billions of pound of support for the economy, with the UK government spending £307bn to prop up the economy during the crisis including £96.8bn for the furlough scheme to protect jobs.
Meanwhile, the BoE poured £440bn into buying government bonds to cushion the economy as public sector borrowing soared to the highest level since the Second World War.
Now, both guardians of the UK economy appear to be winding down their support programmes – meaning Britain will receive a simultaneous clampdown for both monetary and fiscal stimulus.
For Mr Sunak, this potentially reduces the scope he has to spur growth just as the economy is losing momentum.
“Difficult decisions await Rishi Sunak,” said Alison Ring, public sector director at the Institute of Chartered Accountants in England and Wales, who said the chancellor must juggle rising demands from health, education and pensioners for support with limited capacity to help.
Some analysts are now concerned about the fate of the recovery, with fears the chancellor may cave in to temptation with increases for spending and taxes.
“Although March saw a raft of tax raising measures announced, I would not be surprised to see some additional levies announced on Wednesday,” said Mr Cole.
This comes as Mr Sunak has already unveiled more than £31bn in spending measures in the run-up to the budget.
These include a further £6bn to help the National Health Service tackle treatment backlogs, while £3bn will be given to boost post-16 education and almost £7bn will be invested in local transport to help “level up commutes” across the UK.
Other initiatives involve an uplift to the minimum wage, while public sector pay will no longer be frozen and a £1.4bn fund will strive to attract foreign talent to the UK, in turn boosting growth and creating jobs.
A more immediate concern for Mr Sunak, however, is that a rise in interest rates from the BoE would push up the cost of servicing government debt, which is already climbing because of a rise in inflation.
Public sector borrowing, the difference between spending and tax income, stood at £21.8bn last month, according to the Office for National Statistics - £7bn less than September last year when the country was still grappling with the pandemic.
However, current expenditure of £74.1bn was a bit higher than the £73.6bn recorded last September with only a small part of that attributed to the furlough and self-employment income schemes, which wound up in September.
Instead, a high interest payments bill on the debt accumulated during the health crisis hit £4.8bn in September, accounting for more of the monthly spending total, owing to rising inflation.
Earlier this week, Mr Sunak said he was well aware of that danger.
“The risk of inflation and interest rates is one that we can see already today, and there might be other things that we don’t know about,” he said.
“I have to think about what might happen to us in the future and build into our plans some resilience to cope with that uncertainty or the potential adverse shocks that come our way.”
Paul Dales, chief UK economist at Capital Economics, said all the signs are that the chancellor wants to reduce borrowing as much as possible and as quickly as possible.
“To ensure that happens, he may set himself some fairly stringent fiscal rules that will prevent any major net giveaways being announced,” he said.
With Capital Economics expecting borrowing to fall even faster than expected, this means in future Mr Sunak “will have plenty of room to reverse some of the tax hikes and spending cuts scheduled for future years”.
But with so much investment already laid out ahead of the budget, taxes will have to rise further to a degree “to either wholly or partially offset these spending pledges”, said Mr Cole, if the Chancellor was to avoid “losing the confidence of the markets and international investors”.
However, Mr Sunak needs to tread carefully.
Spending pledges such as improving transport links “are unlikely to see consumers ‘jump for joy’ and go out and start spending again”.
At the same time, eroding disposable incomes further through higher taxes, when consumers and businesses are already facing higher prices, will only exacerbate the multitude of challenges facing the economy, said Mr Cole.
The danger is that Mr Sunak chooses to not only increase spending but taxes too with talk of an increase to capital gains tax or pension tax relief being scaled back.
“The chancellor will do something to increase the tax take as he has so far shown little appetite to curtail public spending beyond the measures that were already known, such as the ending of the jobs furlough scheme,” said Mr Cole, with the £7bn for the transport sector already signalling this.
“If the markets are to remain on-side, higher spending inevitably means higher taxes, but any tax enhancing measures are likely to be more focused on scaling back tax reliefs rather than increasing tax rates per se. And he may choose to delay their actual implementation for a future date,” said Mr Cole.
Any move Mr Sunak does make comes as the BoE looks set to increase interest rates to curb spiralling inflation.
Financial markets have already priced in a BoE interest rate rise, with chief economist Huw Pill warning earlier this month that prices may surge well above 5 per cent.
That is at least a full percentage point higher than policymakers estimated in September and 3 per cent above the central bank's target of 2 per cent.
The Treasury estimates every percentage point increase in interest rates, market borrowing costs and inflation adds £25bn to public borrowing annually.
This complicates Mr Sunak’s bid to bring order to the public finances, with the new outlook for tighter monetary policy one reason he is showing restraint. Treasury officials are concerned that more largess would fuel inflation further and prompt a quicker rise in rates from the BoE.
That will leave Mr Sunak likely to announce a few carefully targeted measures to aid groups that have been hit hardest by the pandemic, such as low-income households and those struggling with higher energy costs.
“My instinct is that further tax rises announced on Wednesday will be largely designed to offset any new spending pledges, keeping the budget fiscally neutral," Mr Cole said.
"With the fiscal tightening already in place, this will then provide him with some wriggle room to ease the tax burden modestly ahead of the next election. But these cuts may well turn out to be temporary if he cannot cut back on spending.”