Fiscal Risks Persist - DBRS Morningstar on the UK

After this week's Autumn Statement, experts at DBRS Morningstar look at the UK's economic prospects

DBRS Morningstar 24 November, 2023 | 12:04AM
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Jeremy Hunt

The Office for Budget Responsibility now expects weaker economic growth in 2024 and 2025, after better-than expected growth in 2023. GDP is now expected to grow by 0.7% in 2024, against the March forecast of 1.8%. Likewise 2025 is forecast to see economic growth of 1.4%, down from the 2.5% predicted seven months ago.

The fiscal deficit is expected to remain relatively large this year and next, virtually unchanged compared with the Spring Budget 2023, with the general government debt ratio projected to start declining by the fiscal year 2027-28. 

In DBRS Morningstar's view, risks to the economic and fiscal outlook remain significant, amid still high inflation and high interest rates and in view of the electoral cycle.

The outlook for inflation also points to a more gradual decline than previously expected, with implications for interest rate assumptions. With inflation being more persistent and more driven by domestic factors compared to expectations earlier in the year, the OBR is forecasting inflation to return to the Bank of England's (BoE) 2% target by mid-2025, over a year later than forecast in March.

The modest headroom against the fiscal rules leaves the fiscal outlook exposed to adverse developments. The fiscal headroom is estimated at £13 billion (0.5% of GDP), which largely reflects impact of high inflation, is low by historical standards.

The average since 2010 has been just below £30 billion.

Risks that reduce the fiscal headroom could emerge from government policies, including a failure to implement the indexation of fuel duty, an increase in departmental spending including the NHS, and the unfreezing of the personal tax allowances and thresholds. Additional risks to the fiscal outlook include higher-than-expected interest rates, lower economic growth, and further increases in labour inactivity related to health problems.

The Focus on Labour

On the economy, the tax cuts and welfare reforms are aimed at boosting economic growth. In particular, the reforms to welfare and health services are aiming to increase labour market participation. However, the boost to the economy from all these measures is estimated to be modest at just 0.3% in five years and some measures, particularly those related to investment and the labour market could take time to bear fruits.

A lower-than-expected recovery in the labour supply would weigh on economic growth while higher-than-expected interest rates would likely dampen private consumption.

In our view, uncertainty over the fiscal outlook also increases in view of the electoral cycle. With the government debt ratio projected to fall only after the next general election (due to be held by January 2025), uncertainty over the debt trajectory is high as the fiscal path is susceptible to policy changes in the run-up to the election campaign and, after that, polices could change depending on the outcome of the election.

The commitment of the government to bringing public finances to a more sustainable position remains key for policy predictability. Our sovereign rating for the UK remains at AA with a Stable trend.

This DBRS Morningstar report was compiled by Adriana Alvarado, senior vice president global sovereign ratings and Nichola James, managing director, co-head of sovereign ratings

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