Finance

Sunak to set out new fiscal rules to rein in UK borrowing

UK government spending updates

UK chancellor Rishi Sunak is planning to use next month’s Budget to set out new rules to rein in government borrowing, amid Treasury fears that any rise in interest rates could blow a hole in the heavily-indebted public finances.

Sunak’s new rules will commit him to stop borrowing to fund day-to-day spending within three years — a move intended to illustrate Tory fiscal discipline ahead of the next election.

While the government’s current spending plans fit within the new rules, they allow little room for extra giveaways to be unveiled at the Budget.

According to people briefed on the chancellor’s thinking, Sunak’s fiscal rules will also require underlying debt to start falling by 2024-25; it currently stands at about 100 per cent of gross domestic product.

The spectre of higher inflation — and rising interest rates — is concerning Sunak. “Just a one percentage point increase in both would now cost us over £25bn,” he said in his March Budget.

Inflation in the UK in August rose to 3.2 per cent, its highest level since 2012, and although the Bank of England thinks the rise is manageable and temporary, Sunak is watching it carefully.

“Inflation is one of a number of risks to the public finances that we closely monitor,” the Treasury said. “That’s why the government is taking action to ensure the public finances return to a sustainable footing.”

The Treasury’s previous fiscal rules were suspended during the pandemic. Sunak said in his March Budget that he intended to set out “new fiscal rules later in the year, providing economic uncertainty recedes further”.

Boris Johnson’s backing for Sunak’s fiscal plan has helped to secure a truce between the two Downing Street neighbours after months of tensions over issues including public spending and Covid-19 policy.

The prime minister endorsed Sunak’s insistence that taxes would have to rise to cover a £12bn-a-year boost to health and social care and has also supported other tough spending decisions.

Johnson has also backed Sunak in insisting that the temporary £20 a week uplift to universal credit — which costs £6bn a year — must end as planned at the end of this month.

Sunak earlier this month stood alongside Johnson at a meeting with Tory MPs to urge them to fully support the prime minister, but tensions still lie ahead as the Treasury conducts a three-year review of public spending.

That review concludes on Budget day in October 27, with Johnson pushing for schemes to support his “levelling up” agenda, including expensive transport projects in the north.

In the latest fiscal outlook from March, public sector net debt was forecast to rise from 84.4 per cent of national income in 2019-20 to 106.2 per cent in 2024-25 following the pandemic.

But if the Treasury banks all of the public finance forecast upgrades expected in October, the trajectory of underlying public debt will fall.

This would allow the government to stick to earlier pledges that tax revenues match day-to-day public spending, that servicing the public debt accounts for under 6 per cent of tax revenues and that public sector net investment remains below 3 per cent of national income.

This will require the Office for Budget Responsibility, the independent fiscal watchdog, to go further than revising down public borrowing in 2021-22 after strong tax receipts this year.

It will also need to raise the forecast for medium-term economic growth that comes with changing its assumption that the pandemic will leave the economy 3 per cent weaker than at the start of 2020.

Most other forecasters have become more optimistic with the Bank of England expecting only 1.25 per cent long-term damage to growth from the pandemic. The Institute for Government has estimated that if the OBR matched the BoE’s thinking, it would give Sunak a £25bn a year windfall in the Budget.

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