Borrowing is falling but Sunak faces the most challenging situation for a chancellor in decades
During the last 17 months we have become almost inured to the terrifying increases in government borrowing incurred in grappling with the pandemic.
The government borrowed £303bn during the 2020-21 financial year, a peacetime record, equivalent to 14.5% of UK GDP.
Yet something interesting has been happening during the current financial year.
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Tax burden to reach highest level since 1960s
In each of the first four months government borrowing, while still high, has come in significantly below the levels forecast by the independent Office for Budget Responsibility (OBR).
The latest figures for the public sector finances, published today, revealed that the government borrowed £10.4bn in July.
Make no mistake, this is still a terrifyingly high number, equivalent to borrowing of nearly £233,000 every minute.
It was, however, £10.1bn less than in July last year – and also significantly lower than the £11.8bn that City economists had been expecting.
The figure means that, during the first four months of the current financial year, the government borrowed £78bn – some £26bn less than the OBR had been forecasting at this stage.
There are a couple of key points to make about the numbers.
July’s figures are normally boosted by self-assessed tax returns
First of all, July is usually a strong month for tax receipts and therefore the public finances, because it is one of two months in the year – the other is January – in which the deadline falls due for payments by those completing self-assessed tax returns.
It was not unusual, pre-pandemic, for the government to record a surplus during July.
That appears to have been a key factor this month.
The government enjoyed tax receipts of £70bn during July – up £9.5bn on the same month last year.
Behind that was a £3.7bn improvement in self-assessed tax receipts on the same month last year, when HMRC allowed tax payments to be deferred, chiefly to support the self-employed.
But it probably also reflects that the economy is starting to recover.
VAT receipts were up by £1.2bn on July last year, fuel duty was up by £400m – partly reflecting higher petrol and diesel prices – and regular income tax payments were up by £800m.
There was also a big jump in stamp duty receipts, which at £1.4bn were double the level they were in July last year, reflecting a rush to beat the deadline for the end of the temporary £500,000 nil-rate band.
Fuel duty was up by £400m
Receipts from corporation tax, which is levied on company profits, also came in higher than the OBR had been expecting.
Secondly, government spending was lower, with the government shelling out £79.8bn during the month.
That was down £2.9bn on July last year and probably reflects that, not only did the government begin to taper away its furlough scheme, but also that there were fewer workers participating in the scheme.
Government spending on the furlough scheme during July was down £4.2bn on the same month last year while spending on the equivalent scheme for the self-employed was down £200m.
Worryingly, though, interest payments on the national debt came in at £3.4bn during the month – up £1.1bn on July last year.
As for the national debt, that stood at £2.216trn at the end of July, equivalent to 98.8% of GDP, which the Office for National Statistics (ONS) said was the highest it has been since March 1962.
The figures were welcomed by Rishi Sunak, the chancellor, who has been spelling out the need to restore order to the public finances.
He said: “Our recovery from the pandemic is well under way, boosted by the huge amount of support government has provided.
A rise in stamp duty receipts reflected a rush to complete deals before the winding down of a stamp duty holiday
“But the last 18 months have had a huge impact on our economy and public finances, and many risks remain.
“We’re committed to keeping the public finances on a sustainable footing, which is why at the budget in March I set out the steps we are taking to keep debt under control in the years to come.”
That is not to say the chancellor faces anything other than a major challenge on that front.
Isabel Stockton, research economist at the Institute for Fiscal Studies said: “Even if, as recent revisions to economic forecasts suggest, some of this improvement persists the coming Spending Review will still require some very difficult decisions and, most likely, more generous spending totals than currently pencilled in by the chancellor given the myriad pressures on public services and the benefit system following the pandemic.”
That is why the government sought to cut its overseas aid budget by £4bn – but that is a comparatively small sum in the context of overall government finances.
Elsewhere the government has committed to raise public spending by £55bn this year to help clear backlogs in the NHS and in the courts system.
Most economists believe the ultimate bill will be higher.
That is why the chancellor is dropping heavy hints that a rise in state pensions this year under the “triple lock” – whereby the benefit increases by the highest of 2.5%, inflation or average earnings – is not going to happen.
The government has committed to spending increases to clear NHS backlogs
Were the triple lock to apply, the state pension will have to match the rise in average earnings for May to July which, if as expected comes in at about 8% could cost the Treasury an extra £7bn a year.
Accordingly, Mr Sunak is arguing the lock should not apply.
He can reasonably point out that average earnings growth has been flattered by the fact that, a year ago, it was depressed by pay cuts, mass redundancies and the furlough scheme.
Yet the decision will be politically fraught.
The triple lock was a Conservative manifesto pledge and opinion polls suggest the public opposes scrapping it, even younger voters, despite the intergenerational unfairness implicit in the policy.
Mr Sunak is due already to announce the government’s three year Spending Review this autumn but there is also currently speculation in Westminster about the timing of the next budget.
Some Treasury officials would rather, it is said, have an early budget to nail down the government’s spending and taxation plans for the coming year in order to prevent the prime minister from making outlandish spending commitments ahead of the COP26 summit in November.
Others would prefer to postpone the budget until spring next year so the chancellor can better assess the strength of the recovery and the lasting damage done to the economy by the pandemic.
It is arguably the most challenging situation any chancellor has faced since, Labour’s Denis Healey in 1976
That happened last time when the budget was pushed back from autumn last year to March this year.
Making the chancellor’s job much harder would be an earlier than expected rise in interest rates.
This is due to the way the Bank of England’s asset purchase programme – quantitative easing in the jargon – works.
When the Bank buys a government bond, it credits the account of the seller, who effectively receives a deposit at the Bank.
These are known as “reserves” and the Bank pays interest on those reserves at Bank rate – currently 0.1%.
It means that the cost of QE rises if interest rates do.
All of this adds up to the most challenging situation any chancellor has faced since, arguably, Labour’s Denis Healey was forced in 1976 to seek a bail-out from the International Monetary Fund and possibly since the war.
The UK economy unexpectedly shrank in May, even after the worst of Donald Trump’s tariffs were paused, official figures showed.
A standard measure of economic growth, gross domestic product (GDP), contracted 0.1% in May, according to the Office for National Statistics (ONS).
Rather than a fall being anticipated, growth of 0.1% was forecast by economists polled by Reuters as big falls in production and construction were seen.
It followed a 0.3% contraction in April, when Mr Trump announced his country-specific tariffs and sparked a global trade war.
A 90-day pause on these import taxes, which has been extended, allowed more normality to resume.
This was borne out by other figures released by the ONS on Friday.
Exports to the United States rose £300m but “remained relatively low” following a “substantial decrease” in April, the data said.
Overall, there was a “large rise in goods imports and a fall in goods exports”.
A ‘disappointing’ but mixed picture
It’s “disappointing” news, Chancellor Rachel Reeves said. She and the government as a whole have repeatedly said growing the economy was their number one priority.
“I am determined to kickstart economic growth and deliver on that promise”, she added.
But the picture was not all bad.
Growth recorded in March was revised upwards, further indicating that companies invested to prepare for tariffs. Rather than GDP of 0.2%, the ONS said on Friday the figure was actually 0.4%.
It showed businesses moved forward activity to be ready for the extra taxes. Businesses were hit with higher employer national insurance contributions in April.
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The expansion in March means the economy still grew when the three months are looked at together.
While an interest rate cut in August had already been expected, investors upped their bets of a 0.25 percentage point fall in the Bank of England’s base interest rate.
Such a cut would bring down the rate to 4% and make borrowing cheaper.
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Is Britain going bankrupt?
Analysts from economic research firm Pantheon Macro said the data was not as bad as it looked.
“The size of the manufacturing drop looks erratic to us and should partly unwind… There are signs that GDP growth can rebound in June”, said Pantheon’s chief UK economist, Rob Wood.
Why did the economy shrink?
The drops in manufacturing came mostly due to slowed car-making, less oil and gas extraction and the pharmaceutical industry.
The fall was not larger because the services industry – the largest part of the economy – expanded, with law firms and computer programmers having a good month.
It made up for a “very weak” month for retailers, the ONS said.
Monthly Gross Domestic Product (GDP) figures are volatile and, on their own, don’t tell us much.
However, the picture emerging a year since the election of the Labour government is not hugely comforting.
This is a government that promised to turbocharge economic growth, the key to improving livelihoods and the public finances. Instead, the economy is mainly flatlining.
Output shrank in May by 0.1%. That followed a 0.3% drop in April.
Ministers were celebrating a few months ago as data showed the economy grew by 0.7% in the first quarter.
Hangover from artificial growth
However, the subsequent data has shown us that much of that growth was artificial, with businesses racing to get orders out of the door to beat the possible introduction of tariffs. Property transactions were also brought forward to beat stamp duty changes.
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In April, we experienced the hangover as orders and industrial output dropped. Services also struggled as demand for legal and conveyancing services dropped after the stamp duty changes.
Many of those distortions have now been smoothed out, but the manufacturing sector still struggled in May.
Signs of recovery
Manufacturing output fell by 1% in May, but more up-to-date data suggests the sector is recovering.
“We expect both cars and pharma output to improve as the UK-US trade deal comes into force and the volatility unwinds,” economists at Pantheon Macroeconomics said.
Meanwhile, the services sector eked out growth of 0.1%.
A 2.7% month-to-month fall in retail sales suppressed growth in the sector, but that should improve with hot weather likely to boost demand at restaurants and pubs.
Struggles ahead
It is unlikely, however, to massively shift the dial for the economy, the kind of shift the Labour government has promised and needs in order to give it some breathing room against its fiscal rules.
The economy remains fragile, and there are risks and traps lurking around the corner.
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Is Britain going bankrupt?
Concerns that the chancellor, Rachel Reeves, is considering tax hikes could weigh on consumer confidence, at a time when businesses are already scaling back hiring because of national insurance tax hikes.
Inflation is also expected to climb in the second half of the year, further weighing on consumers and businesses.
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