The tricky part is that the OBR’s forecasts, which feed directly into the central bank’s models, look out over five years, but the BOE’s horizon is two years shorter. The government currently aims to balance the books over three years, although Hunt will almost certainly extend this. Any spending cuts or tax increases that Hunt pushes beyond three years are basically irrelevant to the BOE, as it cannot model the impact of either on growth or inflation. So to influence the BOE forecast, fiscal tightening must be front-loaded in the next two years and be large enough – tens of billions of pounds – to count.
But what makes sense economically and for market credibility may conflict with political reality, particularly if the tax increases upset an already turbulent Tory party. This is where realpolitik comes in for both Hunt and Prime Minister Rishi Sunak: Choosing their poison wisely will determine the future not only of this Conservative government but how the Tory party is perceived towards the next election, to be held in two years.
The ultimate test will be how Thursday’s package affects the value of sterling and the gilt yield. On his way to the G-20 meetings in Bali, Sunak told reporters earlier this week that putting public finances on a sustainable trajectory is essential to “meet the expectations of international markets. ” The government is well aware that it cannot afford to cause the kind of gilt market collapse that brought down Liz Truss after just 44 days in office.
Hunt will no doubt use some sleight of hand to push spending cuts as credibly as possible on the OBR’s five-year timetable. Fiscal drag – not matching spending with inflation, and leaving tax caps unchanged so that real incomes fall – is the most insidious route. Such opaque measures are far from an honest solution; but the promise to be frugal after the next election will not pass muster.
So there needs to be a sufficient short-term increase in revenue from higher tax takings along with enough spending restraint to keep the gilt market calm. The BOE needs to feel confident that a firm grip on public finances will complement its efforts to curb double-digit inflation. Only then can you begin to speed up the pace of interest rate increases.
With the current energy price cap scheduled to expire in April, the reduced but still substantial cost of a tapered replacement focused on the most needy, to be announced on Thursday, will also have is taken into account in the consumer price forecast. As Ana Andrade and Dan Hanson of Bloomberg Economics said this week, “Hunt has a bigger view on 2023 inflation than the BOE.”
But Hunt also wants the opportunity to offer some relaxation from the relentless grind of austerity ahead of the election. It will take some ingenuity not to be too “flashy” with this week’s fiscal tightening, as Hunt has repeatedly warned. It certainly set the stage that everyone will be paying more tax, and in many ways.
The gilt market will be keeping a close eye on government borrowing needs for the remainder of this fiscal year. There may be a slight reduction in the net cash requirement, allowing fewer gilts to be sold through April. However, Hunt may choose not to accelerate the debt sale, knowing that next year’s needs will be much greater. A Bloomberg survey of five gilt traders showed an average expectation of £250 billion of outflows in the next financial year; in addition, the BOE is expected to sell around £50 billion of its QE stock, with a similar amount not reinvested at maturity. The OBR’s forecast will set the longer-term tone for how bond markets cope with the increase in supply.
The more Hunt can do now to tighten the fiscal stance, the less the BOE will need to do on the monetary side. Unfortunately, taking too much fiscal pain up front will plunge the economy into a worse recession than it is already likely to be in, weakening sterling and deepening the hole the government is trying to escape from. It will not be easy to close the fiscal gap without harming growth in the near term, at the same time that rampant inflation needs to be curbed. But getting the government and the central bank on the same page, under the careful scrutiny of the independent watchdog OBR, would be a good place to start.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.
More stories like this are available at bloomberg.com/opinion
