Paul Diggle

Hello and welcome to Macro Bytes, the economics and politics podcast from Aberdeen. My name is Paul Diggle. 

Luke Bartholomew

And I'm Luke Bartholomew. 

Paul Diggle

UK Chancellor Rachel Reeves has delivered her Spring Statement. It wasn't a full-blown budget, but it was an important fiscal event, nonetheless. With the new set of Office for Budget Responsibility forecasts and some significant spending announcements, which markets have watched carefully. So, we're recording this on the afternoon of the Statement, on Wednesday 26th of March. We're joined by Lizzie Galbraith, political economist here at Aberdeen. And we're going to be analysing what was announced, what it means for the UK economy and for markets. Luke, why don't we start with you outlining the economic context for the Spring Statement, the UK growth picture, the global uncertainty, the challenges that the Chancellor was facing?

Luke Bartholomew

So, I think the place to start, actually, is with the previous fiscal statement. So, the budget in the autumn last year, and what the chancellor left herself following that budget, which included quite significant increases in spending and investment, was a new set of fiscal rules. And against those fiscal rules which helped create the fiscal space, as it were, for those spending increases, she left herself headroom of 9.9 billion pounds. And as we actually noted back at the time, that wasn't a particularly large headroom compared to historical context. It didn't leave her much room for wiggle. It didn't allow much space for flexibility if stuff happened. And between the Autumn Statement last year and now, quite a lot of stuff did happen. Perhaps most significantly, was the election of Donald Trump in the US, which has had quite significant implications for the likely course of policy globally and has caused quite a significant repricing in financial markets. So, in that context, UK growth has disappointed. Partly one would argue, I think, somewhat related to the measures announced in the budget. There was some uncertainty, that the budget injected into the economy that's maybe slowed growth a little bit. But on top of that, sort of, broader global uncertainty as well has also been weighing on UK growth. And to put that in context, the OBR has reduced its forecasts for growth this year from 2% to 1%, reflecting that weaker growth environment. And the other thing is that gilt yields, the borrowing cost that the government has to pay, have increased quite significantly as well. And that's largely been driven by global things related to the US, and to an extent also, what's been happening in Europe as well, the increased defence and other spending there which has put upward pressure on borrowing costs in Europe, which are then spilt over to the UK. So that weaker growth picture and the higher borrowing costs have eaten significantly into the chancellor's headroom. Indeed, they have entirely wiped it out. And the OBR announced today that were it not for any of the measures that were announced, the chancellor would be around 4 billion pounds in the red. So that is the context for these announcements, that she's gone the wrong side of the fiscal rules and that needs to be corrected. 

Paul Diggle

Great. And Lizzie, the chancellor did basically four things about that, that fiscal overshoot. There were welfare-spending cuts. There was a tighter path for departmental spending later in the forecast horizon. There was another crackdown on tax evasion that's meant to increase tax take. And there were promises of a more efficient and less expensive public sector. So, let's break some of those down, starting with the welfare cuts and the departmental spending plans. What measures were announced there? How much does it save? 

Lizzie Galbraith

Yeah. So, what we've seen announced is a pretty big package that touches on lots of different elements of the welfare system. So, for the Universal Credit standard allowance, actually, that's going to see an increase, admittedly a very small one from 92 pounds a week for this year, through to 106 pounds per week by 2029. But at the same time, we're seeing the health element of Universal Credit be cut by 50%. And then that's also going to be frozen for new claimants as well. The government's also announcing a billion-pound investments package to try and encourage people currently on benefits to get back into work, alongside additional funding for the Department for Work and Pensions. And collectively, this is all designed to save 3.4 billion pounds. Now, the issue with some of this is, of course, that it's not necessarily that popular among some backbench Labour MPs to be cutting welfare to comply with fiscal rules. Some of them don't like the optics or the politics of that decision. But nonetheless, that's the decision that Rachel Reeves has gone with. But it does make it difficult to see her go back again for a second round of cuts to this department should she need to later on. 

Paul Diggle

And what about the paths for departmental spending? The money that’s to be raised from tax evasion, from public-sector efficiencies, from using more AI, how plausible do we find those kinds of measures?

Lizzie Galbraith

So, I think the word that we're going to hear a lot of when it comes to these elements of the package is going to be ‘credibility’. And in our view, there is a lack of credibility that comes with these announcements. We already did have concerns about the path of departmental spending at the previous budget, the government had quite significantly front-loaded its spending for the first two years of the forecast and then we saw quite a significant drop in departmental spending beyond 2027, that would have implied real term cuts to unprotected government departments. And that's pretty much anything that isn’t Health, Education or Defence. So, still quite a lot of very fundamental services, very pressurised services, caught up in that. We've actually seen that become more exacerbated at this Spring Statement where spending has become even more front-loaded, in part, thanks to some of the additional spending announcements that the government has announced around that welfare spend, this new productivity fund, to try and get those savings, longer term from government expenditure. But the addition of those has meant that in the short term, we're seeing departmental spending actually going up a bit relative to previous plans. And that's offset, then, with even deeper cuts in the final three years of the forecast. So rather than 1.3% average departmental spending increases for the final three years, we're now looking at 1% for the final three years of the forecast. And that does imply some probably unsustainable cuts to public services, given the ongoing demands that we can see. So, I think there are reasons to be pretty sceptical of those being implemented. And likewise, we've heard a lot about governments making productivity savings from the civil service before. Many governments have tried. And that doesn't mean to say that there are no savings to be made, but they're very often a lot harder to achieve than governments would like them to be. So, I think, we may well see those targets underperform and therefore affect governments’ plans later on. 

Paul Diggle

And, Luke, despite some of that scepticism, initial market reaction has been fairly muted to these announcements. Tell us what's moved or what hasn't moved in the markets, and why. 

Luke Bartholomew

Yeah, I mean, these could end up being famous last words. But I think as things currently stand, the chancellor will be reasonably happy with market reaction up to this point. As I say, I mean, much could change as some of these announcements get digested in due course. But yeah, as things stand, the gilt market broadly unmoved by the announcement. I think there are some technical things going on as well as just the fiscal announcements themselves. The Debt Management Office released a new gilt mandate, which required a little bit less gilt issuance in the market as expected. And moreover, just the maturity profile about where those gilts were issued across the curve, I think has come out in a way that’s slightly more favourable for investors as well, in terms of where there is specific demand for certain maturity of debt. And then beyond that, the equity market is up a little bit in the UK, the pound is down a little bit. But it is also worth noting that there was some inflation data in the UK this morning where headline inflation was a little bit softer than expected. And so, there's a sense that maybe that makes it a bit easier for the Bank of England to cut interest rates in May, and that's also the kind of thing that you would expect to put a little bit of upward pressure on equity prices and a little bit of downward pressure on the currency. So, it's quite difficult to disentangle how much of what we're seeing in the market right now is a function of that economic inflation data and how much of it is the budget, or the fiscal, Spring Statement, I should say. But either way, I think the chancellor won't be too displeased as things currently stand. 

Paul Diggle

Bigger challenges could well lie ahead. I mean, for example, we're going to get a potentially very large increase in US tariffs again next week. How vulnerable, Luke, are the spending plans to being blown off course by global events, by global volatility?

Luke Bartholomew

Extremely. So, the chancellor has restored exactly the headroom that she had previously, 9.9 billion pounds. And that wasn't a huge headroom when she first had it back in the autumn, as today's events prove. And it's not a massive headroom today either. There is a significant uncertainty out there, and it really isn't that difficult to see the kind of things that could push the fiscal plans quite significantly off course. So, yeah, you mentioned US trade policy. We're expecting a big announcement next week. Perhaps the UK, in a direct sense, is relatively well-placed around those announcements. Maybe it's less exposed to a big increase in tariffs compared to some other countries. But it's not impossible that the UK does see a big increase on the, on tariffs on its trade, which would hurt the UK. And indeed, if there’s a global trade war that would definitely have negative spillovers to the economy, reduce growth, put pressure on the fiscal path. It's also possible that, you know, as part of the deal, to coin a phrase, that the UK might come up with with the US to avoid tariffs, that they agree the government to give up on its digital services tax. And so, you know, the current fiscal forecast could be based on raising revenue from that tax which, as of next week, ends up being scrapped because that's just what they have to do to avoid some tariffs. And then the big, unexploded bomb in these forecasts is that the OBR continues to have productivity forecasts, growth estimates, that look pretty optimistic. And the OBR quite helpfully have some analysis showing, you know, if productivity doesn't pick up to the level that it is expecting and stays on its current trend, how much that would blow a hole in the public finances, and it would be significant. And the OBR is, I think, broadly considered to have more optimistic forecasts on productivity than other analysts. And so, you know, it's not reasonable at all to think that those numbers end up getting downgraded in time. And if that's the case, I think that does, you know, quite radically shift what the UK's fiscal trajectory looks like and would require really quite significant surgery. So, I think there are lots of reasons for thinking that these numbers, you know, won't stick. And, you know, we might spend the next six months ahead of the autumn budget speculating about what the chancellor has to do next to restore her fiscal headroom. 

Paul Diggle

Well, indeed. And Lizzie, on that note then. So, if the Chancellor finds herself squeezed for fiscal space in the autumn at the next budget, what gives at that point? Are there more spending cuts to be done now? Do taxes rise? And if so, which ones, given the government's commitment not to touch the major tax levers? Are the chancellor's prized fiscal rules themselves even fit for purpose? 

Lizzie Galbraith

So, I think you've basically laid out the series of incredibly unpalatable choices that the chancellor will face, if any one of the ways in which these, the government's fiscal outlook could veer off course, actually materialise. And I think the answer is, broadly speaking, we would be expecting some tax rises if, if that was to happen, in part because the government has gone exclusively for the spending cuts this time around. And with that, it has used up a lot of its political capital, with both its own MPs and likely with its own support base as well. And by political capital, I think we can just sort of take it as, you know, people are currently willing to give the government the benefit of the doubt on, on some of these policies. But if growth doesn't materialise, if you don't see any payoff for any of this, the government probably can't really come back for another slice, from the Department for Work and Pensions, certainly. And there are precious little alternative options when it comes to spending that appear to be able to net enough savings to really be worth it. We've seen some effort to try and make the NHS more efficient. That also appears to be, another avenue that’s sort of blocked off. Defence spending looks set to only increase from here. And there's no really, there's not really any other department has actually seen increases in spending that you could then take away. So, I think the answer would probably have to be the government would look at taxes. Are there any obvious places to go? I don't think there are any obvious places given the increases we saw last time around. But as we mentioned, if it does look like the fiscal rules are going to be breached again, then speculation over the nature of those tax cuts will grow over the next few months. And I think if the government ends up getting itself into a pattern where it's just jumping from fiscal event to fiscal event with very little fiscal headroom and constant speculation over what it will do to alleviate potential breaches in the fiscal rules, then the question will then arise over whether or not these rules are fit for purpose. We're absolutely not there yet, in part because the government was very clear going into the election in 2024 that it wouldn't change the fiscal rules. It already has done that. So, I think a second change would, would use up quite a lot of credibility, particularly for Rachel Reeves herself. But if we get caught in this cycle over the medium term, where we're just constantly chasing a number and having to make policy based on that, then I think it will become a relevant conversation.

Paul Diggle

Okay, well keep praying for economic growth then. Look, that's about all we have time for this week. As ever, please allow me to ask you to like and subscribe to the podcast on your podcast platform of choice. But until next time, goodbye and good luck out there.

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