MNI INTERVIEW: UK Policymakers Risk Rush To Stimulus Exit

The UK Treasury and the Bank of England, faced with higher inflation and elevated debt, appear to be rushing to exit stimulus and risk endangering the economic recovery, James Smith, Research Director at the Resolution Foundation and formerly a senior BOE economist, told MNI.

Chancellor of the Exchequer Rishi Sunak looks set to unveil some form of balanced budget rule in the Budget on October 27, with a goal of bringing day-to-day spending, excluding investment, into line with revenues and debt on to a declining trajectory. That would require exceptionally fast debt reduction by historic standards, Smith said, while if the Bank hikes rates it will push up on debt interest costs, adding to the challenges of getting the budget back to balance.

"Our worry is that the Bank and Rishi Sunak are … both rushing for the exit. And the combination of that can end up just being too tight," Smith said Monday.

SOARING INTEREST PAYMENTS

The UK has, by international standards, an exceptionally high proportion of its debt stock linked to inflation and the BOE remunerates all central bank reserves, some 40% of the debt stock, at Bank Rate, ensuring a rapid pass through of higher inflation and higher interest rates to government debt servicing costs.

On Resolution Foundation figures if, based on Bank forecasts, CPI inflation were to be 1.5 percentage points higher in FY2021-22 and one percentage point higher the next year, that would add around GBP12 billion to the deficit this year and some GBP17 billion over the forecast period.

When the Office for Budget Responsibility publishes its deficit projection on Oct 27 it will, however, not include the latest surge in market rate expectations, now signalling two Bank Rate hikes this year alone, as its forecasts were closed on Sept 24.

GOOD NEWS ENDING

Higher inflation and the clearly slowing pace of the recovery will also weigh on the public finances and "you won't get as much good news as people have been extrapolating from the monthly numbers," Smith said.

One striking feature of recent government finance data has been public sector deficits significantly lower than OBR projections made back in March. But that trend set to end, in part because the ending of pay-outs on the Job Retention Scheme, which remunerates employees who are still on a company's payroll without working, have been markedly smaller than assumed while unemployment has risen less rapidly than expected.

"We have got this GBP31 billion improvement so far. Some of this is obviously going to stop because we are not paying JRS … so that is about GBP7 billion of the improvement that is just going to end," Smith said.

BALANCING ACT

The move to bring the budget into balance and to get debt falling would also be an historically tough challenge.

If Sunak aims to have debt falling within a short-time frame by setting, say, a two-year target, "that will be something that just looks incredibly fast. The really striking fact here is that it is double the pace of debt falls of any five-year period that we can find," Smith said.

"The bit that people seem really fixated on is the Bank. Our view is that the Bank are very marginal partners in that. Tightening from the Bank will be a headwind, but it will be nothing compared to the amount of tightening we are getting from fiscal policy," Smith concluded.