Rising bond yields may douse hope of pre-election UK tax cuts

(Alliance News) - UK public sector borrowing came in below expectations, potentially giving Chancellor Jeremy Hunt enough firepower in government coffers to enact some pre-election tax cuts, but widening gilt yields may put paid to that idea.

Public sector net borrowing, excluding public sector banks, reached GBP4.3 billion in July. This was GBP3.4 billion more than in July 2022. However, it was below the consensus of around GBP5.0 billion, as well as the Office for Budget Responsibility's GBP6.0 billion forecast.

The Office for National Statistics noted it was the fifth-highest July borrowing figure on record. The ONS said monthly borrowing was only higher in July 2020, following the outbreak of the coronavirus pandemic, as well as the July months from 2009 through 2011, during the global financial crisis.

Lloyds Banking Group analysts commented: "With borrowing still undershooting official forecasts, there seems bound to be continued speculation of tax cuts in next year's budget. However, that will also be dependent on the broader economic picture."

The next UK spring budget announcement, due in 2024, will come in what could be an election year, putting even greater importance on the fiscal event. The next UK election must be held before late-January in 2025.

AJ Bell analyst Danni Hewson commented: "The chancellor has responded to today's figures with textbook precision, urging continued caution, fiscal responsibility and no detours from the current conservative course. But privately he must be letting out a rather large sigh of relief that these numbers at least give him a bit of wiggle room to consider crowd-pleasing tax cuts before the next election.

"Whilst he might now be able to cast his eyes over a selection of rabbits, there's no guarantee they'll be suitably fattened up by the time he needs to pull one from his chosen receptacle."

But rising gilt yields could provide a headache for the chancellor. The yield on the 10-year UK government bond stood at 4.69% around 1025 BST on Tuesday, down from 4.73% late Monday, though up markedly from this time last month on robust Bank of England interest rate expectations. Around this time in July, the yield stood at around 4.27% yield.

A robust UK core inflation reading last week Wednesday put more rate hikes on the table. Core inflation - excluding energy, food, alcohol, and tobacco - was unchanged on an annual basis from June's reading of 6.9%. It had been expected to cool to 6.8%.

Higher gilt yields will prevent Hunt from enacting tax cuts next year, Pantheon Macroeconomics analyst Gabriella Dickens believes.

Total borrowing for between April and July stood at GBP56.6 billion, GBP13.7 billion higher on-year, but shy of the OBR's GBP68.0 billion forecast.

Pantheon's Dickens added: "If this trend continues, full-year borrowing will total around GBP110 billion in 2023/24, well below the OBR's GBP132 billion forecast. We still doubt, however, that the chancellor will have enough wiggle room to meaningfully cut taxes or increase expenditure in the run-up to the next general election, which must be held by January 2025. In the most recent budget, the chancellor gave himself headroom of just GBP6.5 billion if he wanted to meet his target of the debt-to-GDP ratio to be falling in five years' time.

"Our calculations suggest that the OBR likely would revise up its forecast for debt interest payments by around GBP40 billion in 2024/25 and by around GBP20 billion in five years' time if it were to produce the equivalent forecasts using today's market expectations for bank rate and the current level of gilt yields. The chancellor could increase borrowing in the near-term and pencil in unspecified spending cuts further down the line to ensure his fiscal rules still were being met. But the turmoil last October suggests markets likely will be less willing to tolerate plans that aren't credible, particularly given the current economic backdrop of high CPI inflation."

At GBP2.579 trillion, the total debt pile was provisionally estimated to have been around 98.5% of the UK's annual gross domestic product in July. This was continuing at levels last seen in the early 1960s, the ONS noted.

Back in July, ONS had said the UK government's debt pile had surpassed the country's economic output in June at 100.8% of annual GDP. It was the first time this had happened since 1961.

However, June's figure was revised down 99.5%, given that the latest GDP estimates for the second quarter were GBP32.5 billion higher than previous estimates.

By Eric Cunha, Alliance News news editor

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