Budget watchdog warns the country is in worse shape to withstand recession than on the eve of 2007 financial crash
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Britain’s public finances are in worse shape to withstand a recession than they were on the eve of the 2007 financial crash a decade ago and face the twin threat of a fresh downturn and Brexit, the Treasury’s independent forecaster has warned.
The Office for Budget Responsibility – the UK’s fiscal watchdog – said another recession was inevitable at some point and that Theresa May’s failure to win a parliamentary majority in last month’s election left the public finances more vulnerable to being blown off course than they were in 2007.
In its first in-depth analysis of the financial risks facing Britain, the OBR said its main message was clear: “Governments should expect nasty fiscal surprises from time to time – because policy can only reduce risks, not eliminate them – and plan accordingly.
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“And they have to do so in the context of ongoing pressures that are likely to weigh on receipts and drive up spending and a variety of risks that governments choose to expose themselves to for policy reasons. Of course, this is true for any government, but this one also has to manage the uncertainties posed by Brexit, which could influence the likelihood or impact of other risks.”
The OBR said the size of the UK’s Brexit divorce bill – currently a matter of dispute between London and Brussels – would have little impact on the public finances. But it noted that even a small fall in Britain’s underlying growth rate after departure from the EU would lead to a big increase in the country’s debt burden.
If a knock to trade with the rest of Europe caused productivity to slip by just 0.1 percentage points over the next 50 years, tax receipts would be £36bn lower. The debt-to-GDP ratio would end up around 50 percentage points higher with spending growth left unchanged, the OBR added.
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The campaign group Open Britain said the OBR’s report showed “a hard Brexit poses a real threat to our economy. People voted for £350m a week for the NHS, not a £36bn black hole in the public finances that could mean severe cuts to the NHS”.
The shadow chancellor, John McDonnell, said years of austerity and the decision to gamble on a general election victory had left Britain in a weaker position going into the Brexit talks. “The Tories want to blame Brexit for their failures on the economy. But what this report reveals is that one of the biggest risks to our economy is Theresa May’s weak government and the last seven years of economic failure,” he said.
The Liberal Democrat spokesman Vince Cable warned that the underlying weakness of government tax receipts and a “reckless approach to Brexit” was a toxic recipe likely to damage the economy. “Even a small deterioration in growth could mean billions of pounds less funding for our public services in the long term,” he said.
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The OBR noted that Brexit was not the only threat to the government’s aim of eliminating the UK’s budget deficit. It said a hung parliament and “austerity fatigue,” alongside longer-term developments such as a rapidly aging population, were also factors putting upward pressure on the deficit.
The almost inevitable likelihood of a recession in the years ahead, along with higher interest rates and inflation, also posed significant risks to the public finances, threatening to put them on an “unsustainable path.”
Robert Chote, the OBR’s chairman, explained that the government could be landed with a higher interest bill on its debt mountain after selling billions of pounds worth of bonds with an interest rate linked to the retail prices index. He said a rise in inflation would add billions of pounds to the cost of financing the UK’s debts.
The warning comes as the chancellor, Phillip Hammond, prepares the ground for his autumn budget, which he has already said should stick to current plans to bring down the deficit by the mid-2020s.
Ministers are known to have begun lobbying for more funds to give additional support to creaking services and offset the most painful cuts in welfare spending. The deficit is due to rise from 2.4% last year to 2.9% this year following a deterioration in the economic outlook. It could go higher if pressure on the Treasury to open the spending taps is successful.
The OBR said: “Ongoing challenges must be faced while negotiating Brexit and in an environment of ‘austerity fatigue.’ [The government] also faces them from a starting fiscal position that is more vulnerable than that which prevailed on the eve of the crisis ten years ago.”
Hammond described the report as a “sober analysis” and a “stark reminder of why we must deliver on our commitment to deal with our country’s debts.” But, he added: “The Labour party would ignore these warning signs from the OBR, adding to the bill that our younger generation will have to pay.”
To judge the sensitivity of the public finances to shocks, the OBR replicated the Bank of England’s stress tests earlier this year on high street banks, which checked their finances were sound and they were holding sufficient reserves to guard against nasty shocks.
A stress test of the government’s plans to manage the public finances revealed that the annual deficit could rocket back to 8.1%, and the debt to GDP ratio could match Italy’s at 114%. The annual deficit for the last financial year was 2.6% of GDP – the lowest since 2007-08 – and the debt-to-GDP ratio is 85%.
Compared with the OBR’s forecast in March, the risks add £66.2bn to the deficit in 2017-18, rising to £158.5bn higher by 2021-22. However, it said that extra spending by the government would account for almost all the shortfall.
A series of measures dropped from the recent finance bill also played a part, the OBR said. The government scrapped 17 measures that were designed to yield £3.5bn for the Treasury. “It is no longer clear when they will return to Parliament to be legislated,” it said.