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.

Time to scare you - "real" national debt figures

 

• Liam Halligan

Statistical skulduggery is turning Britain into a joke

The national accounts are full of cons and tricks – it’s no wonder investors don’t take us seriously

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‘Sir Keir Starmer’s Government has doubled down on Britain’s high-debt, high-tax, low-growth doom loop’ Credit: Andy Rain/EPA

Liam Halligan

09 February 2025 8:00am GMT

This column often focuses on the UK’s national accounts – with good reason. Britain’s public finances are in a parlous state, teetering on the brink of systemic meltdown.

In 1997, when Tony Blair took office, the economy was growing at a rate of 4.9pc a year and the national debt was 36pc of GDP – low by historic standards. Growth continued at 3-4pc per annum for the rest of that parliament – so a relatively small government debt pile remained manageable as a share of total output, allowing the state to borrow and spend more.

Keir Starmer’s incoming administration faced a different situation. Over the previous 14 years, the Tories had overseen a decade of tough fiscal rhetoric during which the national debt actually ballooned, followed by a wildly over-stringent Covid lockdown that weakened our public finances even more.

As a result, Labour entered government last July with Britain in a high-debt, high-tax, low-growth doom loop – with growth at a historically paltry 1.1pc and national debt near 100pc of GDP, a 60-year high.

But Starmer and Chancellor Rachel Reeves, leading a government far more ideologically Left-wing than the Blairites, doubled down. Last October’s Budget raised taxes by another £40bn a year so Reeves could jack up spending even more, not least by awarding sweetheart pay-deals to Labour’s public-sector union paymasters.

This strategy has proved disastrous, as some of us warned from the outset. Government borrowing costs have soared, with the 10-year gilt yield up from 3.7pc in mid-September to 4.5pc now – consistently way higher than during the “mini-Budget crisis” of October 2022 which saw Liz Truss drummed out of No 10.

The pension funds and insurance companies that lend governments serious money are spooked because, far from picking up under Labour, growth has slumped with Britain now probably in recession. Investors judge that a faltering, heavily over-taxed UK economy will struggle to raise the revenues ministers hope for, while Labour lacks the political grit to rein spending in.

The market consensus is Starmer’s Government will keep borrowing and spending even more, raising tax rates ever higher in a desperate bid to plug the gap, driving the economy ever deeper into the doldrums, making our fiscal position even worse.

That’s why gilt yields remain stubbornly high, forcing the Government to spend evermore billions on debt interest each month, despite the Bank of England repeatedly cutting its base rate in a bid to lower economy-wide borrowing costs. The UK’s national debt looks set to soar above 100pc of GDP – which will unnerve financial markets even more.

Yet, as tough as the fiscal outlook appears, the underlying reality is worse. Britain’s headline national debt figure is actually a serious under-estimate of the Government’s true debt burden.

Official public sector net debt (PSND) is £2,674bn on the latest 2023/24 data ­– equivalent to 98pc of GDP. That’s sharply up from 80pc of national output prior to lockdown and less than 40pc just before the 2008 global financial crisis.

This figure, though, is way lower than it should be if you include additional liabilities under three headings: the Bank of England’s asset purchase facility (APF); contractual debts accrued under the private finance initiative (PFI); and, the really big one, mammoth state obligations represented by the still very generous, inflation-proofed pensions enjoyed by millions of public sector workers.

As a result of the APF, the Office for National Statistics (ONS) makes a huge multi-billion-pound deduction from official national debt attributed to “The Bank of England” in our national accounts. This, in my view, is entirely unjustified.

In reality, the Bank is sitting on big losses as a result of its quantitative easing (QE) programme, under which the central bank bought hundreds of billions of pounds of mainly sovereign debt in a bid to boost the economy over the last decade or so. The value of those assets has since fallen. Yet instead of adding those losses to the national debt, the ONS – in a strange metaphysical twist – subtracts them from the UK’s headline debt figure.

“As well as being unjustified, this deduction is dangerous in that it normalises the routine understating of the nation’s indebtedness,” says Bob Lyddon of Lyddon Consulting, a highly-respected economic consultancy specialising in the scrutiny of bank balance sheets. “Such creative accounting leads only to one place: the invention of illusory headroom for further public sector borrowing”. If APF liabilities are added, the headline PSND figure, rises by £179bn to £2,853bn – from 98pc to 105pc of GDP.

To that should also be added the huge liabilities that are still outstanding under hundreds of PFI contracts, a trend which began under John Major’s Conservatives before accelerating sharply under Blair. PFI was used to disingenuously keep public investment off the state balance sheet by relying on private capital instead, with investors guaranteed huge, taxpayer-backed returns for years to come.

Often what was delivered under these contracts were extremely shoddy schools, hospitals and other public infrastructure. Add in £94bn of PFI liabilities, all of which must be legally met by the state over the coming years, and our national debt climbs further to £2,947bn, or 108pc of GDP.

Then there is the often-ignored bill for the very large, index-linked pensions due to civil servants, NHS staff, teachers and some other state workers – paid for not out of invested funds, but current and future tax receipts. That bill, officially estimated at £1,442bn but according to many experts much higher, takes the national debt to £4,389bn – an astonishing 161pc of GDP, two thirds above the headline figure.

The UK’s national accounts are a morass of statistical cons and tricks designed to make our national debt look smaller than it is – a culture Chancellor Reeves has embraced.

It’s no way to run a serious country. No wonder serious financial analysts, and the bond traders they advise, increasingly view Britain as a joke.

You should ALL put this writer on your must-read list:

 

MATTHEW SYED

Old Europe is gripped by a delusion. Get real before it’s too late

The West is living in a fantasy land of free money. Our friends watch in horror, our enemies in delight

Matthew Syed

Sunday December 08 2024, 12.01am, The Sunday Times

What will perhaps confound future historians most is how loudly the alarm bells have been ringing. France, the UK and Germany — the great pillars of the old European order — are crumbling. The rest of the world (and I have family and friends in almost every corner, including some of the fastest-growing challenger economies) can see this, is talking about it and is, frankly, astonished by it.

After the collapse of the Scholz coalition, the defenestration of Michel Barnier and the absurdist relaunch of Sir Keir Starmer last week, I noted one wag on X posting: “It’s like witnessing the fall of Rome but with wifi.” Obviously that’s overegging it a bit, but what astounds this commentator observing from inside the edifice, as it were, is how incapable the peoples of old Europe are at even diagnosing the rot, let alone addressing it.

France is a chastening case in point. I listened to a debate featuring three pundits, including a journalist from Le Monde, as they sought to deconstruct the fall of the PM and possible demise of Emmanuel Macron, and it was like an excerpt from Alice’s Adventures in Wonderland. They calmly (and not unintelligently) talked about the constitutional order, polarisation and the rise of “extreme” parties but didn’t seem to grasp or even glimpse the underlying cause of the problems. This has nothing to do with left or right, Macron or Le Pen, the Fifth Republic or popular divisions. The problem is the French people — the demos, if you will.

• How France fell apart: bitter, bloated and blamed on Macron

France, you see, has had governments of left and right and everything in between while delivering policies of stunning consistency for five decades. Since 1974 the state has run fiscal deficits every year. And the reason for this is obvious to everyone except, seemingly, those living inside the dreamworld. It is the settled and immoveable will of the French people to live beyond their means; to enjoy ever-rising welfare, social spending and subsidies while balking at the higher taxes, longer working hours and delayed pensions required to pay for them. The sovereign debt now stands at 120 per cent of GDP.

There is a word for this, and it is what historians such as Spengler and Gibbon sought to convey in their depictions of the dynamics of civilisational decline: delusional. Barnier’s rather anaemic budget plan was merely to reduce this year’s overspend from 6 per cent to 5 per cent of GDP, but even that led to howls of outrage. Parliamentarians — ventriloquising for an electorate, every section of which has drifted into a state of endemic entitlement — offered a resounding “non!”. So the debt will keep rising, the population will keep ageing, the dependency ratio will keep narrowing and we will find out how deep the rabbit hole goes only when the inevitable bond crisis ignites, with potentially calamitous consequences for France, Europe and, if war by that stage is imminent with the revanchist powers, the world.

The UK electorate is, if anything, even more out to lunch. Not unlike the French, we like to blame “useless” politicians, the electoral system or being inside or outside certain trading blocs, but it’s largely a distraction from the fact that voters have become ever more detached from empirical reality; voters who (as polls consistently reveal) demand Scandinavian public services with American levels of taxation, gleaming new energy infrastructure but not in my backyard, new housing while retaining the local right to veto and triple-locked pensions but not the bill. Look at our anaemic growth, frighteningly expensive electricity and debt interest payments soaring above defence expenditure and behold the wonder of democracy. This is the logical consequence of electoral choices — a feature of our system, not a bug.

Germany has the same root problem, albeit with a Teutonic twist. The nation of Bismarckian realism has spent 30 years ripping off America, the nation on which it relies for its defence, while colluding with the nation that most threatens its security: Russia. Successive leaders have embraced this strategic Ponzi scheme because it enabled them to rig growth figures by outsourcing the costs of protection while embracing dependency on cheap Russian gas, which Putin pitilessly weaponised to weaken European resolve against ever more heinous acts of atrocity. The collapse of Scholz’s coalition is not the cause of the problem; it’s a symptom. Like France and the UK, Germany is an old nation (albeit not unified until the late 19th century) that has drifted into a dreamworld.

And this is what the world sees when looking at us: a civilisation that has lost the very qualities that fuelled its rise. Work ethic. Realism. An inspirational future orientation. Today the UK presides over ever-rising numbers of people on incapacity benefit while scarcely debating the (un)affordability of it. Stats from the World Bank a few years ago (albeit disputed) suggest Europe has 10 per cent of the world’s population, 30 per cent of its economy and 58 per cent of social protection spending.

When reading recently about public sector unions proclaiming the “right” to a four-day week despite collapsing productivity (and our enemies working harder and longer), I couldn’t help reflecting on the work of the historian and general Sir John Glubb. In The Fate of Empires, he noted that it was at the moment of peak vulnerability for the Abbasid caliphate in 9th-century Baghdad — after military takeover and looming bankruptcy — that the people demanded a shorter working week.

Looking around the world merely amplifies one’s sense of the creeping unrealism in old Europe. India may be poor and hamstrung by the iniquitous caste system but it is building like crazy and determined to become a dominant power. Vietnam is a one-party state but securing huge inward tech investment and growing faster than England in the 19th century. Poland and Romania have been backwaters for centuries, but they feel their time is coming. You go to these nations and hear people talking not about rights and entitlements but responsibilities and duties — and defence. They are not looking in the rear-view mirror or cowering in simpering guilt about histories long gone but reaching into the future with courage so palpable you can touch it.

I should note three additional points, which space prevents a fuller examination of. Uncontrolled immigration — legal and illegal — has compounded Europe’s problems, but this policy was emphatically not the will of the people. The utter failure to control borders was not an expression of democracy but its greatest modern betrayal — and it will reverberate decades into the future. One also notes the bureaucratic overreach of EU institutions and ever more visible signs of corruption — this, too, cannot be omitted from any analysis of Europe’s travails. Neither can the increasingly brazen offshoring of the super-rich, who leverage the institutional collateral of Europe to secure vast wealth while siphoning off their tax liabilities.

But I hope it’s possible to be aware of those problems, and to think deeply about how to tackle them, while recognising this column’s takeaway point. Old Europe remains a great power and (to my mind) the best place in the world to live, but its people have drifted into a fantasy land from which they — we — must awake or the world will race ahead of us. And we will be left — with our guilt, culture wars and cat videos — wondering how on earth we let it happen.

Have a look at the options for France:

 

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• Ambrose Evans-Pritchard

For his next stunt, will Emmanuel Macron invoke emergency powers?

The impact of the French president’s dangerous pyrotechnics is making it easier for him to justify recourse to Article 16

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Macron could reasonably argue that failure to pass a budget prevents the country from fulfilling its EU treaty commitments Credit: Ludovic Marin/POOL AFP

Ambrose Evans-Pritchard

05 December 2024 5:51pm GMT

France will have to face the discipline of the global debt markets on its own. The European Central Bank (ECB) cannot legitimately intervene to hold down French borrowing costs unless, and until, the country faces a full-blown financial crisis.

If the ECB were to abuse its legal powers to let France off the hook, it would set off a political and legal storm, and further erode German confidence in the management of the euro.

“France will have to face fiscal reality and dig itself out of the hole that it has dug itself into,” said Holger Schmieding, chief economist at Germany’s Berenberg Bank.

“Nobody on the governing council wants to get mixed up in a French problem. The ECB will intervene only if there is contagion to other countries, or if the spreads reach ludicrous levels,” he said.

That point has not been reached. There is no contagion. Risk spreads on 10-year French bonds over German Bunds have settled at around 80 basis points, and have not risen further since the collapse of the Barnier government.

The market reaction is so far surprisingly gentle, given the dangerous pyrotechnics of Emmanuel Macron over the last two and a half years – which have rendered France literally ungovernable with a fiscal deficit heading towards 7pc of GDP next year.

Some suspect that he would prefer a harsh verdict from the bond vigilantes. The worse the spread, the easier it is for him to justify recourse to Article 16 – the constitutional clause that allows him to assume emergency powers. The “Korean” solution, without the added touch of stormtroopers.

Agnès Verdier-Molinié, the director of French Institute of Public Administration and Politics (IFRAP), says the sorcerer’s apprentices who blocked the budget and defenestrated Barnier on Wednesday have set off a chain of events that they may regret. She thinks Macron will up the ante, invoking the fiscal crisis to pull the trigger on Article 16.

The powers can be invoked if there is a threat to the “execution of France’s international obligations”. Benjamin Morel, a political scientist at Paris-Panthéon, said Macron could reasonably argue that failure to pass a budget prevents the country from fulfilling its EU treaty commitments.

He told Ouest-France, the French newspaper, that France is the only country in Europe where the president can assume these pleins pouvoirs at his own discretion. “Everywhere else it is a separate body that authorises them,” he said.

Charles de Gaulle invoked Article 16 in 1961 following the Algiers putsch by retired army officers. It gave him the temporary powers of a Roman dictator, which he rolled over for almost six months, spicing it up with eyewash about a Communist “revolution from the inside”.

Activation of the clause requires both a “grave and immediate” threat, and a breakdown in the regular functioning of the state. The Constitutional Council can issue an opinion after 60 days. “It remains only an opinion. It does not oblige the president to change tack,” said Mr Morel.

Would Macron really pull such a stunt? Perhaps, if his next premier faces instant dismissal. He might calculate that his enemies could never command the two-thirds majority in both the assembly and the senate necessary to impeach him. But if he did take this fateful step, the nation would erupt. He raised the spectre of “civil war” in June. Article 16 almost invites it.

France risks slow ruin – as does Britain – but it does not face an imminent financial crisis. French spreads approached Greek levels last week but that is a nonsense story, promoted by Barnier himself in a catastrophist effort to sell his rejected budget. Greece is shielded from market forces. Most of its bonds are held by bail-out bodies.

French debt has an average maturity of 8.6 years. It takes a long time for higher borrowing costs to feed through. The growth rate of nominal GDP is still above the average interest rate. Debt dynamics have not yet succumbed to a snowball effect, though that safety margin could vanish if the eurozone core relapses into recession, which may already be happening.

Nevertheless, French yields have been higher than Spanish or Portuguese yields for months. This is an extraordinary development and a warning to the French political class that their country no longer enjoys an exorbitant privilege as co-anchor of monetary union.

The ECB cannot salve French amour propre. It was able to prop up high-debt countries during the deflation years by purchasing €5 trillions (£4.1 trillions) of bonds under the cover of quantitative easing. That is no longer impossible.

The bank has since invented an anti-spread shield (TPI) but has never dared to use it, and for good reason – it is highly contentious and a flaming violation of the no-bail clause in the Lisbon Treaty.

The ECB arrogated to itself the power to buy distressed bonds as it sees fit, but only on behalf of countries that pursue a) “sound fiscal and macroeconomic policies”; b) are not “subject to an excessive deficit procedure”; c) do not have “severe macroeconomic imbalances”; d) where the “trajectory of public debt is sustainable”; and e) where stress is “not warranted by country-specific fundamentals”.

France is in breach of every one.

Markets are betting that the ECB will find some way around this. No doubt it will, in extremis. But Isabel Schnabel, Germany’s enforcer on the governing council, has a message for them. The TPI can only be used to “tackle disorderly dynamics” and to “prevent destabilising interest rate spirals, which might otherwise drag the euro area into a severe crisis”.

Any sustained help would require a “macroeconomic adjustment programme”, which means an austerity package by the EU bail-out fund (ESM) – and probably an IMF regime, given the scale of France’s €3.3 trillion debt.

This would come with tough conditions and require a vote in the German and Dutch parliaments. There is zero possibility that Left-wing Popular Front or Marine Le Pen’s Eurosceptic nationalists would accept such terms, or any terms at all.

Macron is back at square one, but in an even weaker position, amid mounting calls for his own resignation. “No confidence, no government, no budget, no solution,” was the pithy verdict of Arnaud Marès, chief European economist at Citigroup.

The idea of a technocrat coalition is a fool’s illusion in a great political nation like France. There are only two permutations that can plausibly deliver a government. Both are explosive.

Either Macron swallows his pride, lets the Left take charge as the largest bloc, throws what remains of his inglorious party behind it in cohabitation, and accepts that much of his seven-year edifice will be torn down.

Or, he eats his rhetoric, lifts the cynical cordon sanitaire that is so corrupting French politics, accepts that Le Pen’s 11m voters are a legitimate political community, and reaches a pact with her National Rally, ministers and all.

That is to say, he must do overtly what he has been trying to do on the sly whilst hiding behind Barnier. This would lead to a general strike and mass demonstrations, but it would lance the boil.

Macron caused this crisis by systematically destroying the centre-Left and the centre-Right, aiming to construct a nouvel ordre in the centre for his own Jupiterian glorification.

He succeeded in the first part, even if in nothing else. He refused to back down when this blew up in his face in 2022, opting ever since to ram through his agenda against popular and parliamentary will by executive decree.

Nothing can be resolved until Macron either falls on his sword or learns the meaning of democracy and falls on his knees at Canossa.