UK Urged to Slash Spending After Crisis of Investor Confidence

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(Bloomberg) — Britain is facing calls to slash public spending by an amount twice as big as the annual defense budget to stabilize the public finances and halt a snowballing market rout.

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The influential Institute for Fiscal Studies estimated Chancellor of the Exchequer Kwasi Kwarteng will need to find savings of at least £60 billion ($66 billion) to shore up confidence by the time he presents his fiscal plan on Oct. 31.

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The findings set out ways that Prime Minister Liz Truss’s government can keep pledges to cap debt as a share of the economy. It also suggests brutal choices about how to pay for the £43 billion tax giveaway at the center of Truss’s program of tax cuts and support for households struggling with spiraling energy costs.

Kwarteng brought forward his planned statement by three weeks in response to weakness in the pound and government bonds, which intensified after his action yesterday. Investors also shook off the second intervention by the Bank of England in the past month to prevent disorder in a $1 trillion corner of the pensions industry from spreading to other markets.

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The yield on inflation-linked debt rose by the most in at least three decades on Monday. The benchmark 10-year gilt fell, driving up the yield 23.6 basis points to 4.459%, higher than Spain, Portugal or France.

Delivering the savings could require the government to slash deeper into public services already pared to the bone after years of austerity following the financial crisis a decade ago, the IFS said. 

Without action, borrowing will still be running at around £100 billion a year beyond the middle of the decade — £70 billion more than the OBR forecast in March when the economic outlook appeared brighter. 

Truss’s government is already under pressure to endorse an inflation-linked increase in benefit payments instead of allowing them to rise with the slower pace of wages.

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The scale of the cuts needed is immense — about the same as what the budget for education and double what goes for the the military. 

“The specifics of the UK government’s fiscal strategy are under more scrutiny by financial markets than at any point in the recent past,” said IFS Director Paul Johnson. “The chancellor should not rely on over-optimistic growth forecasts or promises of unspecified spending cuts. To do so would risk his plans lacking the credibility which recent events have shown to be so important.”

The IFS projections are based on forecasts from Citigroup, which warned the economy is facing elevated inflation and a moderate but protracted recession. With the Bank of England raising interest rates to fight inflation and the government cutting taxes, monetary and fiscal policy and now in “clear conflict” — increasing risks to economic stability. 

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Ben Nabarro, chief UK economist at Citigroup, said a key risk is that Britain is reliant on “increasingly precarious” foreign investment flows to fund the current-account deficit. He warned that a currency crisis today may not end as well as in 1976 or 1992, when devaluations triggered periods of strong economic growth.

“I would be very wary of pushing markets,” Nabarro said. “Institutional credibility is an absolute must for the UK and any doubts about that run the risk of being hugely destructive.” 

The IFS forecast a budget deficit of almost £200 billion in the current fiscal year, the third highest on record, in part due to government subsidies to help households with their energy bills.

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