Osborne Prepares to Breach Fiscal Rules Amid U.K. Slump

U.K. Chancellor of the Exchequer George Osborne faces the prospect of breaching his self-imposed budget rules as an economy struggling to escape recession drives debt higher and erodes his political capital.

Osborne said this week it’s taking longer than planned to balance the public finances, suggesting he’ll say in his autumn statement to Parliament today he’s no longer on course to cut the burden of government debt in 2015 and may have to extend austerity for another year.

The announcement will leave Osborne open to attacks from the opposition Labour Party, which says he is hampering the economy by trying to cut the deficit too quickly. The chancellor is already struggling to rebuild his reputation after a decision to cut income taxes for the highest earners in his March budget and a series of policy U-turns cost his Conservative Party support with voters.

“He’s in a really difficult place,” said John Curtice, professor of politics at Strathclyde University in Glasgow, Scotland. “The spring budget bombed and his personal credibility is damaged. People have come to doubt the economic competence of the government.”

The challenge facing Osborne will be underlined when he outlines new economic forecasts from the Office for Budget Responsibility, a non-partisan panel of economists that judges whether he has a realistic chance of meeting his fiscal rules.

‘Little Growth’

According to the average of independent forecasts published by the Treasury last month, the economy will contract by 0.2 percent this year and grow just 1.1 percent in 2013 as the crisis in euro region saps demand in the biggest market for British exports. In March, the OBR predicted growth of 0.8 percent and 2 percent.

“You can criticize the government because we have had very little growth since the election because austerity has been too harsh,” said George Buckley, chief U.K. economist Deutsche Bank AG in London. “In his defense, this is not just a U.K. issue.”

The slump has hit tax receipts and fueled expectations that the five-year target for erasing the structural deficit -- originally set for the next general election in 2015 -- may be rolled forward to 2018, extending austerity to the middle of the next parliament. It also means Osborne may miss his target of cutting debt as a share of gross domestic product by 2015-16.

Fitch Warning

Fitch Ratings said in September that pressure on Britain’s AAA rating had increased and there was little room to “absorb further adverse economic shocks in light of the U.K.’s elevated debt levels and uncertain growth outlook.” Net debt stands at t almost 68 percent of GDP last month, according to the statistics office.

Investors often ignore the actions of ratings companies and many say letting the debt target slip is preferable to risking the recovery by sharply tightening fiscal policy, providing he demonstrates a commitment to deficit reduction. Ten-year U.K. government bonds currently pay just 1.8 percent, a third of the yield on similar-maturity Spanish debt.

Osborne may signal further cuts to welfare, while placating his Liberal Democrat coalition partners by raising taxes on the wealthy. Extracting more from the rich may help Osborne reassert his claim to be cutting the deficit fairly. The Conservatives lost support after Osborne cut the top 50 percent income-tax rate in the March budget and the party remains around 10 percentage points behind Labour in opinion polls.

Cabinet Briefing

Osborne briefed Cabinet colleagues on the contents of the autumn statement this morning. “The central message was that Britain is on the right track, that we are dealing with our deficit and our debts in a fair way and that means everyone must make a contribution and we are equipping Britain to succeed in the global race,” Prime Minister David Cameron’s spokesman Steve Field told reporters in London today.

While Osborne has ruled out a so-called mansion tax on the most expensive homes, he’s vowed to crack down on tax avoidance following a public outcry over international companies including Starbucks Corp. (SBUX) that minimize their liabilities in the U.K. He may also increase taxes on the pension savings of the wealthiest, the Sunday Telegraph reported.

To spur economic growth, Osborne will say he is cutting 5 billion pounds ($8 billion) from government departments to pay for capital spending on transport, education and science. He will also outline plans to approve as many as 30 new gas-fired power stations to replace ageing coal, gas and nuclear plants, people familiar with the plans said yesterday.

The budget deficit is on course to overshoot the 120 billion pounds forecast by the OBR in March. In the first seven months of the fiscal year, the deficit climbed to 73.3 billion pounds from 68.3 billion pounds a year earlier.

The OBR will present fiscal projections including and excluding the transfer to the Treasury of billions of pounds of cash held by the Bank of England under its asset-buying program. The decision is designed to address concerns expressed by economists and Labour lawmakers that the transfer flatters the public finances.

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

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

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