U.K. Prime Minister David Cameron won the endorsement of bond investors and Fitch Ratings for the biggest budget squeeze in 50 years. The risk now is that voter discontent and a renewed economic slump foil his plans.
Fitch, which said June 8 that the U.K. faced a “formidable” fiscal challenge, yesterday said the “ambitious” plan ensured Britain would keep its AAA credit rating. The pound and gilts rose for a second day after Chancellor of the Exchequer George Osborne outlined the spending reductions and tax increases to lawmakers in London.
The deficit cuts planned by Osborne and measures proposed by the previous Labour government total 113 billion pounds ($167 billion), 15 percent of the 737 billion-pound budget foreseen for 2015, the Treasury says. Agencies outside the National Health Service and overseas aid budgets face a 25 percent cut over four years. Sales taxes were raised, public workers’ pay frozen and subsidies for housing and children were trimmed.
“The Conservative-Liberal Democrat coalition is now very vulnerable among voters,” said Andrew Hawkins, chairman of pollster ComRes Ltd. “It’s critical that they try to retain electoral support. The government could be under some serious pressure by the end of the year.”
Every income group will suffer because of Osborne’s effort to slash the deficit, the highest among Group of 20 nations. The cuts deepen as Cameron gets closer to the next election in 2015. Osborne said he’d eliminate the structural deficit by then.
“I’m not going to hide hard choices from the British people,” Osborne, at 39 the youngest chancellor since 1886, said. “This is an emergency budget, so let me speak plainly about the emergency that we face.”
Osborne increased value-added tax, a levy on sales, to 20 percent from 17.5 percent, which will raise 13 billion pounds a year. Opposition Labour Party lawmakers shouted “shame” across the floor of the House of Commons in protest.
The chancellor will save 3.2 billion pounds a year by reducing the number of families eligible for tax credits. He’ll also recoup 5.8 billion pounds by imposing tougher checks on those claiming disability benefits and cut 1.8 billion pounds from rent subsidies to the poor.
The pound climbed 0.4 percent to $1.4875 at 9 a.m. in London, and yields on 10-year gilts fell 3 basis points to 3.43 percent.
Osborne told lawmakers he tried to spread the pain evenly. While he announced a two-year pay freeze for public-sector workers, he also imposed a 2 billion-pound levy on banks and increased the rate of capital-gains tax for higher earners.
Labour and its allies in the unions accused the government of trying to shrink the size of the state for ideological reasons.
Mark Serwotka, general secretary of the Public and Commercial Services union, which represents 300,000 workers, said the budget was “regressive” with “attacks on the low- paid, the unemployed, pensioners, the welfare state and the public sector as a whole.” He said the union would help organize “joint union action” to fight Osborne’s plans.
Labour’s acting leader, Harriet Harman, focused much of her fire on the Liberal Democrats, who opposed raising VAT during the election campaign.
‘Let Down Everyone’
“How could they let down everyone who voted for them?” she asked, accusing them of betraying supporters in exchange for a place in the coalition government.
“Of course we can’t get everything we want, but we’ve protected the vulnerable,” Liberal Democrat deputy leader Simon Hughes said.
Yesterday’s policy changes, amounting to about 40 billion pounds a year by 2015, would almost erase a deficit that reached 11 percent of gross domestic product in the last fiscal year. About four-fifths of the correction will be based on spending cuts, with tax increases accounting for the rest.
Employers’ groups such as the Confederation of British Industry and the Institute of Directors welcomed the measures and said they would create a healthier economy. Osborne wooed companies with steps such staged cuts in corporation tax.
Bank of England Governor Mervyn King last week backed retrenchment and said monetary policy could respond if the prospects for growth subsequently deteriorated.
“The government will be looking to the Bank of England to keep monetary policy very loose to offset the aggressive fiscal tightening that has now been put in place,” said Howard Archer, chief European economist at IHS Global Insight in London.
Some economists, though, warned that sucking 40 billion pounds out of the economy might imperil the recovery from recession and ultimately push borrowing higher as tax receipts decline and welfare costs mount. The independent Office for Budget Responsibility revised down its forecasts for employment by 100,000 for each of the next four years as a result of the budget.
“The great danger is that the economy turns out to be weaker than anticipated, both because of the budget and for other reasons, causing government borrowing to be correspondingly higher,” said Roger Bootle, founder of London- based research company Capital Economics and a former Treasury adviser.
While Liberal Democrat lawmakers spoke out in favor of the budget, party supporters may be less satisfied with policies such as reducing welfare benefits.
‘Trajectory and Tone’
“Like Margaret Thatcher’s first budget in 1979 this will set the trajectory and tone for this government,” said Mark Wickham-Jones, professor of politics at Bristol University. “The danger for the Liberal Democrats is that they get caught up in this trajectory and this will lead to an unraveling of their support at grassroots level, unhappy at the possibility of continued cuts.”
The budget came days before Cameron flies to Canada for meetings of world leaders. The Group of Eight is split over how fast deficits should be pared, with President Barack Obama focusing on bolstering growth and German Chancellor Angela Merkel joining Cameron in containing debts.
“Will it cost our coalition some popularity? Possibly?” Cameron said of the budget in an e-mail to party members. Still, the prime minister said, he believes “passionately” that it was “the right thing to do.”