Rachel Reeves, pictured with the prime minister Sir Keir Starmer, has been warned by the OECD that there is “a significant downside risk to the outlook if the fiscal rules are to be met”
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Rachel Reeves has been warned she is at risk of breaching her fiscal rules if the UK economy is hit by a growth shock by the Organisation for Economic Cooperation and Development.
The Paris-based OECD has become the second major forecaster in two weeks to tell the chancellor that her “thin” fiscal buffers mean she could breach her deficit reduction target after the International Monetary Fund did so last week.
In its annual outlook on developed world economies, the OECD downgraded the UK’s growth outlook for this year and next on the back of rising trade uncertainty, high interest rates, and falling household and business confidence. The economy would expand by 1.3 per cent this year, down from an earlier estimate of 1.4 per cent and slow to 1 per cent next year, lower than an earlier projection of 1.2 per cent, the OECD said.
Slowing growth means the UK’s public finances “are a significant downside risk to the outlook if the fiscal rules are to be met”, the OECD said.
“Currently very thin fiscal buffers could be insufficient to provide adequate support without breaching the fiscal rules in the event of renewed adverse shocks.”
Reeves left herself just under £10 billion in breathing room to meet her fiscal rules in the spring — one of the narrowest buffers on record. The chancellor’s main fiscal rule is to balance day-to-day spending with tax revenues by the end of the parliament.
The OECD’s intervention comes ahead of next week’s spending review, where Reeves is under pressure to manage ministerial budgets over the next three years after a recent U-turn on limiting winter fuel payments to pensioners.
The OECD advised the chancellor to strengthen the public finances with a “balanced” spending review and autumn budget which “combines targeted spending cuts, including closing tax loopholes; revenue-raising measures such as re-evaluating council tax bands based on updated property values; and the removal of distortions in the tax system”.
According to its projections, the UK’s budget deficit is on course to shrink from 6 per cent in 2024 to 4.5 per cent next year on the back of higher tax receipts. But higher market borrowing costs and interest rates mean the debt pile will expand to 104 per cent of GDP in 2026.
“Further supply-side reforms, including the overhaul of the National Planning Policy Framework, are expected to increase potential output and could help to lower fiscal pressures in the longer run,” the OECD said.
The Bank of England is expected to slowly loosen monetary policy with three interest rate cuts over the next 12 months, the forecast said.
In its first projections since President Trump launched his tariff policy, the OECD said global growth would expand by 2.9 per cent this year, compared to a March forecast of 3.3 per cent. The US received one of the biggest downgrades, with the economy expected to slow to a pace of 1.6 per cent this year after a 2.8 per cent expansion in 2024. Consumer price inflation will also climb to an average of 3.2 per cent from 2.5 per cent last year.
“Weakened economic prospects will be felt around the world, with almost no exception. Lower growth and less trade will hit incomes and slow job growth,” Alvaro Pereira, chief economist of the OECD said.
Can the government get more people working without exposing the vulnerable?
Illustration: Mariaelena Caputi
|Barnsley
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For Sarah, the trouble started with a fracture in her back. She’d worked in a warehouse for years. Now she’s “too old to lug boxes” and her back still aches when it’s cold. Poundland, a budget retailer, rejected her job application. Others didn’t reply. For Mandy, it was losing her job. Without that structure, she felt anxious and depressed. Michael hurt his back in 2022, but is still waiting for surgery. He’s only done part-time Christmas work since.
All three live in Barnsley, in northern England. Ill health pushed them into the ranks of what statisticians drily call the working-age economically inactive: people with no job who have stopped looking. Nearly 3m Britons aged between 16 and 64 are not working because of poor health, up from just over 2m in 2019. That is a misery for them and a mystery to economists. No other rich country has seen a similar rise.
Chart: The Economist
Worklessness is a headache for the government, too. Since 2019 annual spending on health-related benefits for those of working age is up by £19bn ($25bn, 0.7% of GDP) in inflation-adjusted terms (see chart 1). The government has forecast a further £13bn rise by 2029. It is spending more on both incapacity benefits, for people unable to work, and disability benefits like the Personal Independence Payment (PIP), which cover the cost of disability whether the recipient works or not. In England and Wales 4m people, or one in ten of working age, now claim one or both. In 2019, only 2.8m did. And losing so many from the jobs market has compounded wider economic woes, pushing up inflation and pulling down growth.
Chart: The Economist
Have Britons really got so much sicker, so quickly? The evidence is mixed and messy. Official labour-force figures show a particular deterioration in mental health among the young, alongside bone and muscle trouble in the middle-aged (see chart 2). But nearly all sickness is up. And since the pandemic, the data have become ever less reliable, as fewer people respond to surveys.
Chart: The Economist
Over a wider set of measures, the Institute for Fiscal Studies (IFS), a think-tank, found no consistent picture (see chart 3). “Some surveys suggest long-term ill health has grown, while others suggest it has remained unchanged,” says Eduin Latimer of the IFS. “There is much clearer evidence on mental-health conditions. All surveys suggest that more people are reporting mental-health problems now than before the pandemic.”
What, then, is going on? Health-service waiting lists get blamed, but probably unfairly. A study by the Office for Budget Responsibility (OBR), the fiscal watchdog, found that most people on them were working or past retirement age, and that even halving the lists would get only 25,000 of the long-term sick back to work.
A more plausible culprit is the welfare system. Britain is spending a record 4.3% of GDP on benefits for working-age people. But most benefits that are not related to health, such as unemployment support, have been squeezed. (The state pension is a marked exception.) That decline has probably shunted more people into health benefits. Court rulings also forced Theresa May’s government to widen eligibility for people with mental-health problems.
A technological shift has also added to the bill. During the pandemic, phone and video interviews replaced face-to-face assessments for disability and incapacity benefits. TikTok is full of tutorials walking would-be applicants through PIP interviews, listing key things to mention—struggling with cooking, forgetting to take medication—to maximise the likely award.
Chart: The Economist
Once the welfare system has deemed someone ill, the label tends to stick. Sir Steve Houghton, leader of Barnsley council, says post-industrial areas like his have long experience of this. “If they’re in the benefits system for over three years, it’s not easy to get people back out,” he says. “They fear if they come out and work doesn’t work out, going back in will be difficult.” Research by the Resolution Foundation, another think-tank, also found that the newest PIP recipients are less likely than previous cohorts to move off the benefit (see chart 4).
Worklessness frustrated the previous government, too. Rishi Sunak tightened eligibility for incapacity benefits in 2023, but was challenged in court over the length of consultation. The government lost in January (after winning last year’s election, Labour kept fighting the case). Now fiscal necessity has jolted Sir Keir Starmer into action. New OBR forecasts, due on March 26th, are expected to show that the government’s already slim room for manoeuvre has been squeezed to nothing by weak growth and the gilt market. The newly urgent need for rearmament spending has made things tighter still. After the overseas-aid budget, now stripped almost bare, benefits are the next least-popular bit of public expenditure.
Leaks to ITV, a broadcaster, suggest the government is eyeing cuts of around £6bn a year. That will be controversial within Labour. At a meeting of the party’s National Executive Committee in January, Sir Keir was warned that “the disabled community were deeply alarmed”. Measures to raise the bar for disability and incapacity benefits are a necessary stopgap. But Britain’s recent history of welfare changes is littered with the unforeseen consequences of misbegotten schemes, and suffering for society’s poorest as a result. PIP, rolled out in the 2010s, was intended to make disability benefits harder to get, and to save £1.4bn a year. The latest estimates suggest it saves only £100m or so.
So reform is needed too. That means somehow framing eligibility in a way that does not penalise people’s efforts to start working, without hurting those who cannot. At least Labour has electoral time and a huge parliamentary majority on its side.
Barnsley is running a pilot scheme, starting in April, to better tie together the 70-odd training and support programmes for jobless people and collaborate with employers to find them work. The Treasury is watching. If the scheme succeeds—its designers expect four-to-one returns—it could be rolled out nationally.
But the government’s own policies are an obstacle to improvement. Most people don’t fall out of work instantly. Like Sarah, they first look and then, after enough disheartening rejections, stop trying. It would therefore be wise to make it cheaper and less risky for employers to take a punt on someone with a thin CV and poor health.
Sadly, the rest of Labour’s jobs agenda is rowing in the opposite direction. Increases in employers’ national insurance, a payroll tax, and the minimum wage will make hiring the low-paid costlier. The Employment Rights Bill will probably block up the job market more. Progress will be hard without a change of course. ■
If Britain is hurtling towards a sterling crash, nobody has told the global currency markets.
The pound is today trading at the top of its post-Brexit referendum range against the euro near €1.20. It is massively overvalued against the Japanese yen. The sterling trade-weighted index is near a nine-year peak.
And if this country is insolvent and heading into the arms of the International Monetary Fund – an article of faith on the British political Right – nobody has told the debt markets either.
Credit default swaps (CDS), which measure bankruptcy risk on five-year UK debt, are a well-behaved 23 points, lower than for the US (31), France (35), Canada (40), China (55), Italy (56), Saudi Arabia (62) and Brazil (171).
Few countries are lower. These contracts strip out inflation risk, and therefore offer a quick and dirty insight into residual default risk.
The sophisticated view among hedge funds and global wealth managers is that the British economy is gradually recovering from a string of shocks – Covid, Putin’s gas squeeze, disentangling itself from the barbed wire of Brussels – and may prove to be an outperformer in the late 2020s.
The UK is more open than Europe to disruptive tech and artificial intelligence, despite much exhilarating talk from Emmanuel Macron in Paris this week. The UK is less prone to erecting regulatory and trade barriers at the slightest excuse, and is therefore likely to see a faster spurt of catch-up productivity growth.
The notion that Britain may soon need an IMF bailout akin to the sterling crisis in 1976 plays fast and loose with historical context. “It is nonsense,” said Dario Perkins, global strategist at TS Lombard.
Denis Healey was borrowing in dollars, which the Bank of England cannot print, in order to defend an indefensible exchange rate. The post-war model was disintegrating. Class war had reached fever pitch. The fiscal deficit was 10pc of GDP and inflation had just peaked at 27pc. Opec petrostates were pulling their money out of London.
“In 1976 we hit a complete crisis point. The politics were broken, the economy was broken, the UK was still hanging on to being a reserve currency,” Perkins said.
“None of that is happening today. We have a flexible exchange rate. We’re not going to have a sudden tipping point and a balance of payments crisis: we’re in a totally different world.”
Nor is this anything like the ERM crisis in 1992, when the Bank of England had to raise rates to 15pc during a deepening recession and a property crash, in order to defend sterling against the D-Mark just as the Bundesbank was on the war path over Germany’s reunification boom. Cardinal lesson: never subcontract your monetary policy to another country by pegging your currency.
This is not to forgive Labour for its awful first Budget. Slumpflation fears set off genuinely alarming moves on the markets a few weeks ago, chiefly because global investors felt duped. Strenuous efforts to soothe them ever since – and a recognition that global capital stays only where it is loved – have mended the rift.
Yields on 10-year UK bonds have dropped half a percentage point from their peak and are no longer trading at a penalty over US treasuries. Nor are they now out of alignment with the eurozone core, which “enjoys” lower structural yields only because it is a dead zone in the grip of Japanification.
The latest data on foreign direct investment from UN Trade and Development (Unctad) show that the UK was a star performer last year, capturing a 32pc rise in greenfield projects to $85bn (£69bn). Europe saw a 45pc drop in total FDI, with falls of 60pc in Germany and Poland.
The UK’s top project was Blackstone’s £10bn plan to build Europe’s biggest hyperscaler at Blyth, on the Northumberland coast. Data centres are now deemed “critical national infrastructure”, making it easier to bulldoze through planning obstructionism. The campus – Project Wind – will be powered mostly by North Sea wind turbines.
Blackstone is a hard-nosed $1.1 trillion US asset manager. It would not spend £10bn on an electricity-devouring data centre if it believed scare stories about a coming British power crisis. It is betting on the opposite outcome.
As a Conservative, my advice to the Tories is to stop wasting political capital railing against clean tech because a) it makes you look economically primitive, and b) it will come back to bite you in four years. There are genuine reasons to attack Labour, not least its levelling-down assault on British schools.
From my angle covering the world economy, the UK looks better than it does when seen from the inside. Most of the globe is in some sort of trouble. Bond and currency markets are ultimately a contest of the least ugly.
Lord Agnew, a Tory ex-Treasury minister, portrays Britain as a particular basket case, on “suicide watch”, borrowing and squandering as if there were no tomorrow.
I agree that the UK has long been living beyond its means, relying on foreign capital to cover trade and fiscal twin deficits. It has racked up a net international investment position of minus £837bn – though the US worries me more, at minus $23.6 trillion.
Nevertheless, I think our bad predicament is getting better rather than worse.
The UK’s current account deficit was 6.2pc of GDP in early 2016, evidence of insidious macroeconomic imbalances under EU membership, but also of depleting North Sea oil and gas reserves.
The structural deficit has since closed to 2.8pc. The big beast in the remaining gap is energy, biting again this week as gas prices spike to a two-year high.
But energy imports are on a descending path as electric cars and hybrids displace petrol vehicles, renewables displace gas in power plants, and heat pumps displace gas boilers in homes. The UK will eventually become a large exporter of offshore wind to Europe, regaining the position it once had as a regional energy powerhouse.
The National Institute of Economic and Social Research says the UK needs sustained public investment of 4-5pc of GDP per year to escape decline and catalyse a hi-tech economy.
Labour talked big before the election but then spent most of its £142bn in extra borrowing this parliament on pay deals for its friends. Net public investment will be just 2.4pc of GDP by 2029, better than recent history, but still below the G7 average.
It is hard to be giddy with enthusiasm but the UK has other strengths, thankfully, and the curse of paralysing Nimbyism has been lifted. The Bank of England is cutting rates. Less fiscal drag is coming from austerity.
This year may not be as bad as many fear.
If there is a major threat to the UK’s long-term prospects it comes chiefly from the un-British and feral character of our current political discourse.
We gracelessly hounded Rishi Sunak from office for sins that most cannot remember, and there seems to be a pathological urge to do much the same to Sir Keir Starmer.
We all need to lay off social media for Lent and calm down.
Stop moaning – the economy is in better shape than it looks
Labour’s Budget was terrible – but we have more to fear from pathological doom-mongering