Cameron Reaches ‘Crunch Time’ as Investors Warn Against Retreat

British Prime Minister David Cameron hosted his top aides for a Sunday lunch at his country retreat as they ended 23 weeks of infighting that resulted in the deepest budget reductions the U.K. has ever seen.

Now comes the hard part: convincing everyone else to go along.

Cameron’s Chancellor of the Exchequer George Osborne, who was at the Oct. 17 lunch with Deputy Prime Minister Nick Clegg and Treasury Chief Secretary Danny Alexander, will detail his plan in Parliament today to virtually eliminate the 156 billion- pound ($245 billion) deficit by 2015.

At stake for the five-month-old coalition government is Britain’s top credit rating, a fragile recovery from its longest recession on record and the future shape of the post-war welfare state. The cuts “will affect every single person in our country,” Cameron has said and investors say they’re concerned he won’t be able to hold the line as ministers plead for extra money to fund child-welfare programs or avoid police layoffs.

“The markets will be very disappointed if he goes back on this,” said Stephen Lewis, a senior economist at London-based Monument Securities. “It will be as hard if not harder to implement. There will be a lot of spending at the local level where we don’t know what sort of issues will arise.”

A June 22 blueprint foresees average cuts in ministries of 25 percent, with the National Health Service protected. As many as 500,000 government jobs may be lost by 2015, says the Office for Budget Responsibility, the watchdog set up by Osborne to oversee Treasury forecasts.

Spending Cuts

Total spending in Cameron’s plan would fall by 0.7 percent a year after inflation. Under Margaret Thatcher, 85, who was known as the Iron Lady during her 11 years as premier that ended in 1990, spending rose by an annual 1.2 percent.

“This looks like it’s going to turn the economy right down and I think it’s going to be a terrible, terrible mistake,” former Bank of England policy maker David Blanchflower said in an Oct. 18 Bloomberg Television interview.

Andrew Russell, professor of politics at the University of Manchester, said Liberal Democrats, the junior partners in the coalition, will push to limit cuts for the poor, particularly in areas such as social housing.

“Cuts mean jobs losses, and when you have two parties, you double the potential for rebellions,” said Russell. “This is crunch time and, while the coalition won’t break, you’d expect fissures to emerge and the Liberal Democrats to look for concessions every time a cut is announced.”

Gilts Gain

So far the budget plan has won over investors. Gilts have returned 7 percent since Cameron replaced Labour Prime Minister Gordon Brown in May, more than the 4 percent gain by German bunds and the 5.8 percent increase in U.S. Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. The pound has gained more than 5 percent against the dollar.

Ratings agencies have warned against any slippage. Fitch Ratings in June said it saw “significant fiscal risks” and questioned whether spending restraint and welfare reductions can be achieved. Moody’s Investors Service said “reduced political commitment to fiscal consolidation” would be a reason for it to reassess its U.K. Aaa debt rating.

“Markets have been remarkably patient,” said Danny Gabay, director of London-based Fathom Financial Consulting and a former Bank of England and government economist. “It’s because the U.K. has chosen to take these steps voluntarily that the markets have cut them some slack.”

Osborne’s Spats

The task of negotiating the plan fell to Osborne, with Cameron forced to intervene as disagreements became public.

The most visible struggle was over the military budget. Service chiefs and Defense Secretary Liam Fox pushed to water down Osborne’s bid to slice 20 percent. They finally agreed to an 8 percent cut.

Cameron and officials at Downing Street grew increasingly exasperated as defense staff leaked details of negotiations to reporters, said people familiar with the talks. In the final two weeks, Cameron ordered Cabinet Office secretary Oliver Letwin and Jeremy Heywood, Downing Street’s top civil servant, to broker meetings between the Treasury and the Ministry of Defense.

Cameron named Colonel Jim Morris of the Royal Marines as military assistant last week to strengthen his hand after clashing with Fox over the cuts.

Leakers Warned

As leaks increased, Osborne told political advisers from other ministries that he would personally end their careers if he found out they had been briefing the media before the spending review, said a person familiar with the meeting.

The wrangling with Work and Pensions Secretary Iain Duncan Smith over the welfare budget was also acrimonious. Private sniping became public when Osborne this month announced he would scrap child-benefits payments for 1 million middle-class families to save 1 billion pounds a year without notifying senior members of the Cabinet, the Daily Telegraph reported on Oct. 6.

The popular backlash prompted Children’s Minister Tim Loughton to say the government may look at “compensating measures for those genuinely in need.” Conservative lawmaker Jo Johnson said the policy change “needs to be tweaked.”

While the biggest fights have been among Conservatives, junior members of the coalition also have expressed dissent.

Liberal Democrat Energy Secretary Chris Huhne said Oct. 8 that proposed spending cuts aren’t “lashed to the mast” and that it “may be appropriate” to change plans unless the economy strengthens.

“It would be very damaging if Osborne had to backtrack,” said Stewart Robertson, chief European economist at Aviva Plc, which has 250 billion pounds under management.

To contact the reporters on this story: Gonzalo Vina in London on gvina@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net

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