Analysis: Bank of England recession warning shines spotlight on UK fiscal plan

LONDON, Nov 4 (Reuters) – The risk of a two-year recession in Britain, flagged this week by the Bank of England, underscores the high stakes for Prime Minister Rishi Sunak and his finance minister Jeremy Hunt then as they prepare to announce major tax increases and spending cuts.

The BoE said on Thursday that Britain’s economy would contract for eight straight quarters – the longest such period in at least a century – if interest rates rose as much as financial markets had recently forecast.

It would be a longer and shallower economic contraction than those that followed the COVID-19 lockdowns and the global financial crisis of 2007-09.

But the context of high inflation this time limits the policy options available to the government.

Even if borrowing costs are no longer rising at all, the BoE’s forecast still paints a bleak picture of a shrinking economy in five of the next six quarters under pressure from a cost-of-living squeeze. .

Central bank officials stress that their mission is to bring down inflation which is currently above 10%, more than five times their 2% target, and that short-term economic difficulties will be needed to achieve this.

“Our focus is ultimately not on the real economy. Our focus necessarily, because we’re managing monetary policy, is to contain inflation,” BoE chief economist Huw Pill said Friday in a statement. an interview on CNBC television.

“(The) slowdown in the economy is what we foresee necessary to contain domestic inflationary pressures to achieve our goals,” he added.

Against this backdrop, Sunak and Hunt must come up with a fiscal recovery plan that not only reassures investors who have taken fright from former Prime Minister Liz Truss’ unfunded tax cut plans, but also limits the blow. brought to the economy.

The pound fell to a record low against the US dollar following the Truss mini-budget and the Bank of England had to step in and buy £19billion of government bonds to end a sell-off of assets by British pension funds.

Hunt has warned of tough tax and spending decisions as he prepares to announce the new government’s first budget package on November 17.

Jagjit Chadha, director of the National Institute for Economic and Social Research, a think tank, said typical responses to the recession would not work given that the main problem in Britain, and many other wealthy economies , was an inflationary energy price shock.

“This is not a recession that we should be offsetting with lower interest rates and expansionary fiscal policy,” Chadha said. “Having said that, we have to help the poorer households that have been through some pretty hot years.”

The media has suggested that Hunt and Sunak could take this approach by considering raising taxes on dividends and capital gains and extending a windfall tax on energy companies to help plug a £50billion hole. in public finances, although analysts also expect a tightening of public spending as well.

Luke Bartholomew, chief economist at fund management company abrdn, said the ruling Conservative Party learned from its own experiences with austerity a decade ago that spending cuts hurt the economy more than tax increases.

But the real test for Sunak and Hunt and their ability to keep their own lawmakers sympathetic to their fiscal medicine would come next year, when a scheduled 2024 election looms and the economy inevitably slips into recession.

The Conservatives have a long way to go to catch up with voters. The opposition Labor party had a 26-point lead over the Tories in a YouGov opinion poll conducted on November 1-2, up from an 8-point lead on the eve of Truss’ mini-budget.

“There’s not much they can do” to avoid a recession, Bartholomew said. “The problem is keeping it as superficial as possible and getting out of it by 2024 so they can go to an election saying we’re in recovery.”

Additional reporting by David Milliken; Writing by William Schomberg; Editing by Jon Boyle

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