Very relevant for the "disruptors to growth" lesson - UK/financial rules

 

Rachel Reeves warned of risk to fiscal rules amid growth downgrade

OECD cuts forecast for UK growth for this year and next on rising trade uncertainty, high interest rates, and falling confidence

Mehreen Khan

, Economics Editor

Tuesday June 03 2025, 8.00am, The Times

Economics

Rachel Reeves

Spring statement 2025

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”

REUTERS

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.

• OECD warns Reeves over risk to fiscal rules – follow live

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.

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JULIET SAMUEL

Bond crisis leaves Rachel Reeves with nowhere to go

Surging borrowing costs have put the chancellor in a precarious position and Trump policies may cause further trouble

Juliet Samuel

Wednesday January 08 2025, 9.00pm, The Times

Well, this is awkward. Just months ago Labour swept to victory with a promise to usher in a wonderful new era of extremely boring sensibleness. Out with the clownish, wet lettuce Tories and their car crash economics, in with Rachel “Treasury” Reeves and her menacingly stiff bob. “Stability is the change,” as Keir Starmer inspiringly told a grateful nation.

And now look at what’s happened. Borrowing costs are soaring. They’re higher than when Liz Truss thumbed her nose at bond markets. Long-term borrowing costs are higher than they were just before the financial crisis. The last time His Majesty’s government had to offer investors yields this high, Tony Blair had just taken office and gilt markets were still on their long comedown from Black Wednesday.

It’s looking so bad that all the boffins are already predicting Reeves will have to come crawling back to parliament with more tax rises in the spring, breaking yet another promise (on top of the promise not to raise taxes) that she wouldn’t go around fiddling with fiscal policy all the time.

And thanks to Reeves’s own bill, the Budget Responsibility Act, shoved through parliament within weeks of the election, any fiscal fiddling now requires the Office for Budget Responsibility to produce a full-blown forecast, with charts and slides and lots of chin-stroking showing how utterly awful it all is. Unless, of course, she wishes to make use of the only legal loophole she granted herself, of declaring her measures a “temporary response to an emergency”. This in turn would surely require the chancellor to change her haircut to some kind of Mohican or frazzled professor look, giving the game away completely.

In its extremely lukewarm response to the chancellor’s first budget, the OBR predicted that all her extra spending would raise the cost of government borrowing over time. The yield on five-year gilts (ie the annual interest cost of borrowing for five years) was around 3.8 per cent, which the OBR had forecast would creep up to 4.1 per cent by 2030. The budget, it predicted, would push that up to 4.5 per cent. It turns out this was wildly optimistic. In fact, five-year yields shot over 4.5 per cent yesterday, less than three months after the budget that was meant to bring back sensible.

Reeves’s fundamental mistake was to believe that by demonstrating the proper respect for bond markets she could get everything to go back to normal. She failed to confront the truth that the old “normal” is gone, banished by the Covid borrowing splurge, the return of inflation, the ineptitude of central banks and the can-kicking simply reaching the end of a very long road. The Truss fiasco wasn’t the cause of the change; it was simply the most reckless and destabilising way of revealing it.

• Juliet Samuel: Tech firm’s fate shows Trump is right on China

The proximate reasons why we cannot keep the show on the road any more are that our economy is not productive enough to sustain it, the state, in particular, is too inefficient, our population is ageing too quickly and migration is now costing the exchequer money instead of saving it. But looming over these considerable domestic concerns is a larger, even more intractable global problem in the form of US policy.

Starmer and co have plenty of reasons to loathe the Trump administration, but this week’s kerfuffle in gilt markets gave them yet another one. They could argue credibly that it is market anticipation of Trump economic policies that prompted the sell-off in gilts over here. When Reeves unveiled her budget in the autumn, the conventional wisdom was that global interest rates were generally on their way down, thanks to lower inflation and slowing growth. But the conventional wisdom was wrong, especially after the US election. Inflation does not appear to have been tamed as comprehensively as most investors thought and the usual suspects are now convinced that Trump will make it worse by cutting taxes, raising tariffs and deporting millions of migrant workers.

Whether or not this is correct (and such predictions proved wrong last time around), the US continues to suck in stocks of the world’s surplus cash to feed its vast spending on government programmes and consumption. Every other country that similarly relies on a constant inflow of money from elsewhere to finance itself, funded by constantly selling assets like bonds or houses, is in competition for the same cash. And Britain has relied on foreign cash for years. Our rising borrowing costs are an indication that we are having to work ever harder to keep it all going.

How the Trump show plays out is extremely difficult to predict. Based on what happened last time, tariffs seem unlikely to have too much of a malign effect on their own, especially if the US taxes other countries more than it taxes Britain. But there are so many moving parts: what happens to the dollar and what Trump decides to do about it, whether he embraces a radical new approach, like capital controls, how much he cuts taxes, how many workers America needs and how many it gets, what the impact of artificial intelligence is on jobs and growth and, crucially, whether Elon Musk can fulfil his vow to purge the government of wasteful spending.

This last point, perversely, leaves Starmer and Reeves in the position of having to hope their evil billionaire nemesis can pull it off. Every dollar the US can avoid borrowing potentially leaves an extra 80p in the big global lending pot for Britain.

We all know that Reeves isn’t to blame for how the US taxes widgets, but she has certainly played a bad hand very badly indeed. Entering what promised to be a hugely turbulent era, she left herself almost no room for manoeuvre, fiscally or politically, and six months in, has used it all up and more. In opposition she killed off Labour’s plans for green spending and higher welfare. In government she has annoyed pensioners and attacked business. If, after all of this, she can’t even deliver placid bond markets, then even Starmer will be forced to start asking the question: what exactly is Rachel Reeves for?

In long-form interviews before the general election, the chancellor liked to humble-brag about how, in her geeky university days, she had a treasured picture of Gordon Brown on her college room wall. Politely, no one pointed out how those glory days ended, with that plaintive cry in 2008: “It started in America.” As any keen student of Treasury lore could tell you, the line didn’t work for Gordon and, when the time comes, it won’t work for Rachel either.

Fiscal rules - time for a rethink?

 The case for rethinking fiscal rules is overwhelming 

Rather than exerting useful discipline, they are constraining government investment

ANDY HALDANE.  The writer, an FT contributing editor, is chief executive of the Royal Society of Arts 

 Last month, I discussed the negative feedback loop between stalling economic growth and expanding safety nets. How do countries break free from this “doom loop”? One important element is to rethink the fiscal rules shaping government investment decisions. 

 The idea of fiscal rules, which place limits on governments’ borrowing, is a sound one. Governments should abide by a “good ancestor” principle, endowing future generations with assets and income, not encumbering them with debt and taxes. In this way, fiscal rules can help ensure intergenerational equity — they are the everyday equivalent of aiming to leave your children the house rather than the mortgage. 

 After a sequence of pandemic-related splurges in government spending, fiscal rules are now at serious risk of being breached. The US is facing a cliff-edge next month due to the debt limits imposed by Congress. In the EU, calibration of the Stability and Growth Pact’s limits on countries’ debt is proving acrimonious. And in the UK, fiscal rules requiring a falling debt ratio within five years are restricting the government’s ability to put in place long-term growth-enhancing policies. 

 Are these rules exerting useful fiscal discipline or constraining investment and growth? I believe the latter. They are typically based on the stock of government debt relative to income. We would expect this ratio to vary over time. The greater the challenges facing a nation state, the stronger the case for debt-financed investment in the public goods needed to rise to them. 

 Take the UK. Since the industrial revolution, ratios of debt to gross domestic product in the UK have, on average, doubled every century. This was an explicit societal choice to invest in the new sets of public goods necessary to support economic and social progress — from schools to housing to health. 

Other countries’ debt ratios have also tended to trend higher over time. We should not necessarily expect this pattern to repeat itself in the 21st century. But nor should we expect debt ratios to flatline or fall. 

Many advanced economies are facing challenges no less severe than those our ancestors faced. And the case for a new set of public goods to meet them is just as compelling. This highlights a second defect with existing fiscal rules: they are typically based on net financial debt. They do not recognise the non-financial assets created by public investment, whether tangible (roads, hospitals, schools) or intangible (intellectual property, data, code). 

Nor do they recognise investment in natural assets, such as clean water, air and a thriving biosphere. Recognising those assets would give us a measure of the true net worth of the government. Just as a company or household would look at their net worth when making investment choices, so too should government. 

Countries with high net assets have been found to have lower borrowing costs. Bond market vigilantes target poor ancestors, not borrowers. That’s why real government borrowing costs have trended downwards over the centuries, despite government debt ratios trending upwards. 

Financial markets know it is the value of the house, not the mortgage, that matters. Countries with higher net worth also tend to exhibit greater macroeconomic resilience. This then reduces the burden on the state when adverse shocks strike. 

Our current debt-based fiscal rules, by constraining public investment, have contributed to a reduction in macroeconomic resilience and a bulging of the safety net following shocks. That has been the story of the past few decades when public investment by G7 countries has been flat or falling, despite global real rates of interest being close to zero. 

Here was an opportunity to invest in economic and environmental regeneration and boost growth and macroeconomic resilience. Misguided fiscal rules meant it was wasted and the doom loop perpetuated. 

 Global real yields have since risen across the world. But with real rates still under 1 per cent globally, the cost/benefit calculus would overwhelmingly favour public investment today to support growth and resilience tomorrow. Recent skirmishes over debt limits in advanced economies mean this opportunity is at risk, once again, of being squandered. Adhering to existing fiscal rules risks underinvesting today in tomorrow’s economic and environmental health. 

As the evidence of the past few decades demonstrates, debt-based fiscal rules dent growth, weaken macroeconomic resilience and amplify the doom loop. Future generations will rightly consider us bad ancestors if we stick with them.