Let’s start with the good news. This change of Prime Minister undoubtedly makes a difference for the better. The Conservatives have finally found a leader with a decent chance of making it until the next General Election, providing some much-needed political stability.
The financial markets have reacted positively too: the pound has strengthened, the cost of government borrowing has fallen, and investors have trimmed their expectations for how far the Bank of England will raise interest rates. This should ease the pressure on the cost of mortgages, in particular.
Investors prefer certainty and Rishi Sunak is, of course, a known quantity. The new Prime Minister’s credibility has been enhanced by his warnings of what might gone wrong if his predecessor lost the confidence of the markets.
Nonetheless, the economic situation remains difficult and could be about to worsen. There are two main challenges, but it will be hard to meet both at once.
The first and most immediate challenge is to support households and businesses through the winter and beyond, as the UK joins other major economies in recession. This suggests that fiscal policy should be geared towards boosting incomes and confidence, thus propping up demand.
That was the thinking behind Liz Truss’ Energy Price Guarantee, the cancellation of the increases in National Insurance and in Corporation Tax, and the bringing forward (by one year) of the planned cut in the basic rate of Income Tax. Most independent observers agreed that these proposals reduced the risk of a severe recession, albeit at the cost of another jump in government borrowing.
The second challenge is to come up with a credible medium-term plan to fill in whatever “black hole” the Office for Budget Responsibility (OBR) now finds in the public finances. Here, the pro-growth strategy of “Trussonomics” has been abandoned in favour of the return to the old Treasury orthodoxy.
It is now widely assumed that the fiscal gap can only be closed by tax increases and spending cuts, which in turn will add to the downside risks to the economy. Indeed, this could see a quick return to the old “doom loop” of higher taxes, lower spending, weaker growth – and a further deterioration in the public finances.
The contradictions here are already clear. The reversal of the increase in National Insurance is one of the few measures that seems to have survived. But Jeremy Hunt has signalled that the Energy Price Guarantee will be scaled back to a more targeted scheme in April, prompting some chilling headlines about what might happen to bills in the spring.
The large increase in Corporation Tax, originally announced by Sunak himself, will now surely go ahead. This will drag the UK down the tax competitiveness league tables at just the wrong time. More “windfall taxes” would only add to uncertainties faced by businesses looking to invest here.
Hunt has also signalled that the planned cut in the basic rate of income tax might be scrapped altogether.
There is still time for some comfort. It would help if the new team commits quickly to raising non-pensioner benefits in line with inflation, especially as low-income households are already being hit hardest by higher fuel and food bills. The sharp fall in wholesale natural gas prices will also reduce the cost of maintaining the Energy Price Guarantee, or at least reduce the hit to households if it is scaled back.
In short, the political uncertainty at least has eased and the markets are reassured. But the economic outlook has darkened further.
This piece was first published in the i on 24 October 2022