MNI INTERVIEW: UK Budget Ups Inflation Pressure - OBR Miles

MNI (LONDON) - The UK Budget’s hefty increase in public spending only partially offset by tax hikes will push up on inflation over the next year or so by increasing demand before higher investment spending improves the economy’s supply side, senior Office for Budget Responsibility official and former two-term Bank of England Monetary Policy Committee member David Miles told MNI.

"Instead of sitting pretty much at the Bank of England target of 2%, which is a forecast that we might have considered central before the package of measures in the Budget ... the impact of the significantly higher government spending pushes up demand relative to the supply potential of the UK economy [and] drives inflation a bit above the inflation target," Miles said, speaking after the OBR raised its interest rate projections 25 basis points above pre-Budget market expectations. 

The change in the OBR's fiscal projections may be reflected, at least in part, in the Bank of England’s November forecast and in its subsequent analysis, Miles noted.

"We'll have to wait and see ... what they make of it. It's not a trivial change - inflation being two and a half, 2.6 percent, for a couple of years is not trivial relative to 2%," Miles said. (See MNI INTERVIEW: UK Budget Investment Spending To Curb Rate Cuts)

SPENDING INCREASES

The rise in government spending from the new Labour administration is sizeable compared to projected increases under the Conservatives,

"Government spending is, over the forecast of the next five years, on average, about 70 billion pounds a year more. And that's 1,000 pounds more government spending for every household in the UK. They only claw back about half of that extra 1,000 pounds in actual taxes. So that's what generates a level of demand which is probably a bit above productive potential for a couple of years," Miles said. (See MNI INTERVIEW: UK Borrowing For Investment Risky - OBR's Miles)

The switch to a new debt measure, Public Sector Net Financial Liabilities, provides insufficient additional headroom compared to the fiscal target to protect much against shocks or even relatively moderate shifts in the economic outlook, he said.

"The headroom is relatively small ... about GBP15 to 16 billion or so at the end of the forecast ...about five years from now. That's half a percent of GDP. So it wouldn't take a substantial shock, good or bad, at all for that 15 to turn into 30 or zero or turn negative," Miles said. (See MNI INTERVIEW: UK To Ease Debt Target, Avoid Net Worth Target)

HOUSEHOLD SAVINGS

One uncertainty in the OBR's forecasts is whether the recent rise in the household saving rate will be sustained. BOE Monetary Policy Committee member Catherine Mann said at a recent Washington event that she had previously assumed higher savings were "dry powder" for future spending, but had begun to consider whether they could persist in the face of fiscal pressures and other uncertainty.

The OBR raised its central forecast for the household saving rate ex-pensions by 2.5 percentage points on average from 2024 to 2026, showing it rising to over 7.75% in early 2025. Miles noted, however, that UK savings were starting from a low base by international standards.

"The UK and the U.S. are amongst the lower savings rate countries amongst the richer countries in the world by some margin. So it's not that the UK has a high household savings rate, it's just that it's a bit higher than it was before Covid. And it may be ...that that's a reflection of some heightened uncertainty," he said.

To what extent the Budget will sway the savings rate is a moot point.

"Whether or not the budget measures increase that uncertainty or give people a better sense of where the direction of public policy is going - because it looks like this government's going to be here for some time and that was not so clear with the previous government - is not obvious. It's not clear that uncertainty has increased, nor that it's decreased as a result of the Budget itself," Miles said.