MNI INTERVIEW: UK Fiscal Headroom Only Clear After Spending Review

MNI ((MNI) London) - MNI (LONDON) - The next UK government will only get a clear view of its fiscal headroom after a Departmental Spending Review due to be completed by the end of this year, former top Office for Budget Responsibility official Andy King told MNI.

The current government has not set out departmental spending limits for coming years, and official OBR’s forecasts are based on broad brush spending totals which imply real-term cuts for many departments over the next five years but say nothing about the affordability of pay increases or progress on capital spending, King said in an interview.

"The OBR has covered things on revenue and on annually managed expenditure. But departmental expenditure, if there's not a Spending Review ... it's a black box," King said, speaking ahead of Thursday’s election, which polls indicate will result in a large majority for the opposition Labour Party. (See MNI INTERVIEW: UK Budget's Imaginary Cuts A "Fiscal Fiction")

"We all know that they're tight. How tight? ... When they [Labour] come in they will have to make a decision about public sector pay for the year in progress, but also for public sector pay next year ...  I don't think anyone knows whether there's enough money for whatever percentage increase, but the guess is that there isn't," King said.

A host of things have not been fully budgeted for by the current government, including plans for the National Health Service, increases in defence spending and payouts for mishaps including the infected-blood scandal, said King, adding that "the list goes on.”

BOE BALANCE SHEET

One change that Labour could justifiably make to get extra headroom, in King's view, would be to revert to including the Bank of England in the target debt measure. The BOE’s balance sheet was excluded in October 2021 for fear that projected repayments of its Term Funding Scheme loans to banks would provide a false picture of falling public sector indebtedness towards the end of the target horizon, and its reinclusion would provide a notional year-on-year gain to fiscal headroom of GBP16 billion. (See MNI INTERVIEW: UK Likely To Restore BOE To Debt Calculation)

"That could only be used for investment really, because the headroom is so tight on the current budget ... [and] issuing the gilts to finance the investment pushes up debt interest spending, which is current spending, which tightens the headroom for the current balance. So it's all, it's all quite, quite difficult, but it is definitely more space with inc-BOE than ex-BOE," said King, who was on the OBR's ruling body, the Budget Responsibility Committee, until August 2023 and is now at consultancy Flint Global.

Including the BOE in the target measure will also neutralise the fiscal effect of gilt issuance to pay for the Treasury’s indemnification of losses incurred during quantitative tightening, noted King.

"The majority of what's going on is you just change Bank of England debt – from buying gilts at a premium – into central government debt – when the Treasury makes good the Bank’s losses on gilt sales under the indemnity. So the public sector total hasn't changed," King said.

The OBR's assumptions about the pace of QT and market assumptions about yields and Bank Rate "are causing the ex-BOE measure to fall by less than the [measure including the BOE] in year five. So the question, if you look back at the decision in 2021... is 'is the current setup ... making life harder for a reason that looks sensible?', and I just don't think it is. So I think there is a perfectly reasonable case for switching back," he said.