How fiscal headroom has come to dominate Westminster and why it could decide the next election

Published

1 year ago

January 23, 2024

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“Fiscal headroom”. It is a desperately boring term, meaningless to many. Yet this bit of economic jargon may well have the power to swing the next election.

It is thanks to fiscal headroom that the chancellor may be able to splurge on billions of pounds of tax cuts in the coming months, hoping to lift the Conservatives’ sagging polls. It is on the basis of “fiscal headroom” that Sir Keir Starmer will decide whether he can go ahead with his much-vaunted plans to invest untold amounts in Britain’s energy sector.

All of which raises a rather important question – what is fiscal headroom anyway?

Happily, the explanation is quite simple. When politicians talk about fiscal headroom they are mostly talking about something quite specific; the room they have to spend money before they break their fiscal rules.

Ever since Gordon Brown, successive chancellors have imposed rules to discipline their borrowing. These rules have changed over time – mostly when the chancellor of the day realised he was about to break them. Today’s chancellor, Jeremy Hunt, has a few such rules but the most important one – the one he and pretty much everyone pays most attention to – is the rule about the national debt.

This rule states that he has to show that he is bringing down Britain’s net debt (in other words, the amount the state owes) as a percentage of gross domestic product (GDP) within five years.

There is plenty of logic in trying to keep the national debt under control. While there’s no hard and fast rule about precisely what level of debt is “safe” or not, there are many episodes throughout history of countries getting into big economic trouble when they allow their national debt to rise too high (since it often means higher debt interest payments, which can spiral out of control).

The fiscal equivalent of St Augustine’s prayer

But it’s also worth pointing out at this point that this rule is actually a lot less strict than it might at first sound. It’s not saying “bring the debt down immediately”. It’s saying “you can absolutely increase the national debt if you want to, provided it looks like it’s on the way down five years from now”. It is the fiscal equivalent of St Augustine’s prayer: “Lord, make me good. But not yet.”

And the current government plans aim to do precisely that. The figures in last November’s autumn statement show that its preferred measure of the national debt (there are many – don’t ask) actually rises in the coming years, from 90.2% of GDP in 2023/24 up to 95% of GDP by 2026/27.

Only in the following years does it start to fall, quite gradually, to 94.9% of GDP in 2027/28 and then to 94.4% of GDP in 2028/29. And, since it’s falling, the debt rule is met. Hurrah!

If at this point you’re still following, you’ve probably noticed a few things.

First, these supposedly strict fiscal rules aren’t actually stopping the national debt from rising. It’ll be considerably higher in five years’ time than it is today.

Second, the rate at which the debt is falling towards the end of this decade is actually quite slow.

Third, we seem to be fixating quite a lot on a couple of years (the difference between 2027/28 and 2028/29) which are a long way away, way beyond the government’s current spending plans.

And you’re right on all three. But no matter, because if all you care about is fiscal headroom, all that matters is the difference between those two figures, 94.9% of GDP and 94.4% of GDP. And that difference works out, in actual money, at about £13bn.

A made-up rule

Now, I could have easily skipped the preceding paragraphs and begun this article with this fact. Headroom equals £13bn. That, after all, is what most of Westminster does.

But every so often context can come in useful, and in this case the context underlines something important. Namely, that headroom is not an immutable law of economics. It is the product of a self-imposed rule. It is, to put it more bluntly, made up.

But this made-up number has an enormous bearing on economic policy right now. Since both the Conservatives and Labour have adopted the same fiscal rule, they also find themselves having to bend their knee to the god of headroom.

Jeremy Hunt says he won’t spend any more than the headroom he has at the next budget. Which, to translate, means he’ll probably spend nearly all the billions of headroom he has. Rachel Reeves says while she would like to invest £28bn on green energy technology projects, she won’t do it if it breaks the fiscal rules.

So the questions of how many tax cuts the chancellor offers this year and how much Labour will invest in the energy transition both hang on this made-up number. Indeed, the two things are related, since if Mr Hunt splurges a lot in the coming months, there’s no headroom left for Ms Reeves if she gets into office.

One of the single most important numbers in politics

Some would say this is all a bit silly. And they might just have a point. But since both main parties have agreed to respect this concept of headroom, it is among the single most important numbers in politics right now.

Yet here’s the other thing. What looks like a monolithic number is actually changing all the time. Since “fiscal headroom” is actually the difference between two other big numbers (the national debt four years hence, minus the national debt five years hence) which change quite a lot when the economy gets bigger or smaller or taxes come in faster than expected, it has a tendency to yo-yo around from one year to the next.

Consider this – last March, the Office for Budget Responsibility (OBR) was saying the amount of headroom was a mere £6bn. Not much, in other words.

But then, at the autumn statement, we learned that the public finances turned out to be in a better state than expected. That, plus the fact that there was an extra year until the deadline, increased the potential headroom by nearly £25bn in one fell swoop. So what looked like £6bn in headroom actually turned out to be £31bn of headroom.

All of which is why the chancellor was able to splurge £18bn in November (on those National Insurance cuts) and to leave us still with a supposed £13bn headroom this time around.

And something similar is likely to happen again when we get to March’s spring budget. The public finances are looking a bit healthier than expected. This morning’s public finance figures showed the deficit and debt interest payments were both lower than anticipated.

The upshot is that most economists think that £13bn of headroom could actually be anywhere up to £23bn. So there’s more money for the chancellor to spend, should he see fit.

It’s possible that at this point your head is spinning. Perhaps you’re wondering why on earth Westminster is tying itself in knots to stay true to a fiscal rule which was only made up a few years ago. Perhaps you’re wondering why the future of this economy hangs not on the question of the smartest long-term policy but on the difference between a few decimal places on a spreadsheet produced by the OBR.

These are all good questions. But mentioning them in Whitehall these days is tantamount to blasphemy. Trust, instead, in the creed of fiscal headroom. Everyone else is.

Business

UK-US pact neither a free-trade agreement nor broad trade deal of Brexiteer dreams

Published

1 hour ago

May 9, 2025

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UK-US pact neither a free-trade agreement nor broad trade deal of Brexiteer dreams

Sir Keir Starmer was at home in Downing Street, watching Arsenal lose in the Champions League, when he got a call from Donald Trump that he thought presented the chance to snatch victory from the jaws of trading defeat.

The president’s call was a characteristic last-minute flex intended to squeeze a little more out of the prime minister.

It was enough to persuade Sir Keir and his business secretary Jonathan Reynolds, dining with industry bosses across London at Mansion House, that they had to seize the opportunity.

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The result, hurriedly announced via presidential conference call, is not the broad trade deal of Brexiteer dreams, and is certainly not a free-trade agreement.

It’s a narrow agreement that secures immediate relief for a handful of sectors most threatened by Mr Trump’s swingeing tariffs, with a promise of a broader renegotiation of “reciprocal” 10% tariffs to come.

Most pressing was the car industry, which Mr Reynolds said was facing imminent announcements of “very difficult news” at Britain’s biggest brands, including Jaguar Land Rover, which sounds like code for redundancies.

In place of the 25% tariffs imposed last month, a 10% tariff will apply to a quota of 100,000 vehicles a year, less than the 111,000 exported to the US in 2024, but close enough for a deal.

It still leaves the car sector far worse off than it was before “liberation day”, but, with one in four exports crossing the Atlantic, ministers reason it’s better than no deal, and crucially offers more favourable terms than any major US trading partner can claim.

For steel and aluminium zero tariffs were secured, along with what sounds like a commitment to work with the US to prevent Chinese dumping. That is a clear win and fundamental for the ailing industries in Britain, though modest in broad terms, with US exports worth only around £400m a year.

In exchange, the UK has had to open up access to food and agricultural products, starting with beef and ethanol, used for fuel and food production.

In place of tariff quotas on beef that applied on either side (12% in the UK and 20% in America) 13,000 tonnes of beef can flow tariff-free in either direction, around 1.5% of the UK market.

The biggest wins

Crucially, sanitary and phytosanitary (SPS) production standards that apply to food and animal products, and prevent the sale of hormone-treated meat, will remain. Mr Trump even suggested the US was moving towards “no chemical” European standards.

This may be among the biggest wins, as it leaves open the prospect of an easing of SPS checks on trade with the European Union, a valuable reduction in red tape that is the UK’s priority in reset negotiations with Brussels.

Farmers also believe the US offers an opportunity for their high-quality, grass-fed beef, though there is concern that the near-doubling of ethanol quotas is a threat to domestic production.

Technology deals to come?

There were broad commitments to do deals on technology, AI and an “economic security blanket”, and much hope rests on the US’s promise of “preferential terms” when it comes to pharmaceuticals and other sectors.

There was no mention of proposed film tariffs, still unclear even in the Oval Office.

Taken together, officials describe these moves as “banking sectoral wins” while they continue to try and negotiate down the remaining tariffs.

The challenge from here is that Mr Trump’s “reciprocal” tariff is not reciprocal at all. As commerce secretary Howard Lutnick proudly pointed out in the Oval Office, tariffs on US trade have fallen to less than 2%, while the UK’s have risen to 10%.

As a consequence, UK exporters remain in a materially worse position than they were at the start of April, though better than it was before the president’s call, and for now, several British industries have secured concessions that no other country can claim.

From a protectionist, capricious president, this might well be the best deal on offer.

Quite what incentive Mr Trump will have to renegotiate the blanket tariff, and what the UK has left to give up by way of compromise, remains to be seen. Sir Keir will hope that, unlike the vanquished Arsenal, he can turn it round in the second leg.

Business

Energy customers secure compensation for overcharging error

Published

4 hours ago

May 9, 2025

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Energy customers secure compensation for overcharging error

Tens of thousands of household energy customers have secured payouts after a compliance review found they had been overcharged.

The industry regulator said that 10 suppliers had handed over compensation and goodwill payments to just over 34,000 customers. The total came to around £7m.

Ofgem said those affected, between January 2019 and September last year, had more than one electricity meter point at their property recording energy usage.

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It explained that while suppliers were allowed to apply multiple standing charges for homes with multiple electricity meters, it meant that some were “erroneously charged more than is allowed under the price cap when combined with unit rates”.

The companies affected were revealed as E.ON Next, Ecotricity, EDF Energy, Octopus Energy, Outfox The Market,
OVO Energy, Rebel Energy [no longer trading], So Energy, Tru Energy and Utility Warehouse.

Of those, Octopus Energy accounted for the majority of the customers hit.

Ofgem said that the near-21,000 customers impacted had received compensation of £2.6m and goodwill payments of almost £550,000.

The redress was revealed at a time when energy bills remain elevated and debts at record levels in the wake of the 2022 price shock caused by Russia’s invasion of Ukraine.

Higher wholesale natural gas prices over the winter months meant that the price cap actually rose in April when a decline would normally be seen.

The latest forecasts suggest, however, that bills should start to decline for the foreseeable future.

Charlotte Friel, director of retail pricing and systems at Ofgem, said of its compliance operation: “Our duty is to protect energy consumers, and we set the price cap for that very reason so customers don’t pay a higher amount for their energy than they should.

“We expect all suppliers to have robust processes in place so they can bill their customers accurately. While it’s clear that on this occasion errors were made, thankfully, the issues were promptly resolved, and customers are being refunded.”

The watchdog added that all ten suppliers had updated their systems and processes to prevent the error occurring in future.

Business

Interest rate cut to 4.25% by Bank of England

Published

22 hours ago

May 8, 2025

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Interest rate cut to 4.25% by Bank of England

The Bank of England has cut interest rates from 4.5% to 4.25%, citing Donald Trump’s trade war as one of the key reasons for the reduction in borrowing costs.

In a decision taken shortly before the official confirmation of a trade deal between Britain and the United States, the Bank’s monetary policy committee (MPC) voted to reduce borrowing costs in the UK, saying the economy would be slightly weaker and inflation lower in part as a result of higher tariffs.

However, it stopped short of predicting that the trade war would trigger a recession.

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Further rate cuts are expected in the coming months, though there remains some uncertainty about how fast and how far the MPC will cut – since it was split three ways on this latest vote.

Two members of the nine-person MPC voted to reduce rates by even more today, taking them down to 4%. But another two on the committee voted not to cut them at all, leaving them instead at 4.5%.

In the event, five members voted for the quarter point cut – enough to tip the balance – with the accompanying minutes saying that while “the current impact of the global trade news should not be overstated, the news was sufficient for those members to judge that a reduction in Bank Rare was warranted.”

Even so, the Bank’s analysis suggests that while higher tariffs were likely to depress global and UK economic growth, and help push down inflation, the impact would be relatively minor, with growth only 0.3% lower and inflation only 0.2% lower.

Governor, Andrew Bailey, said: “Inflationary pressures have continued to ease, so we’ve been able to cut rates again today.

“The past few weeks have shown how unpredictable the global economy can be. That’s why we need to stick to a gradual and careful approach to further rate cuts. Ensuring low and stable inflation is our top priority.”

The Bank raised its forecast for UK economic growth this year from 0.75% to 1%, but said that was primarily because of unexpectedly strong output in the first quarter.

In fact, underlying economic growth remains weak at just 0.1% a quarter.

It said that while inflation was expected to rise further in the coming months, peaking at 3.5% in the third quarter, it would drop down thereafter, settling at just below 2% towards the end of next year.