U.K. Chancellor of the Exchequer George Osborne should abandon his debt target rather than risk damaging the economic recovery by introducing new austerity measures, according to a Bloomberg News survey of economists.
All except one of 18 economists polled between Sept. 21 and Sept. 28 said missing the goal of starting to bring down government debt as a share of output by 2015-16 is preferable to extra spending cuts at a time when the economy is mired in recession. Most said further austerity would alarm investors more than letting the debt target go, which may risk the U.K.’s top credit rating.
“There are no easy options for the government here,” said Melanie Baker, chief U.K. economist at Morgan Stanley in London. “The least worst option, we think, would be to stick to the existing austerity plans and make no attempt to repair the fiscal slippage.”
The findings provide leeway for Osborne as a weaker-than-forecast economy blows his fiscal planning off course, threatening a key plank of the deficit-reduction strategy created after the Conservative-led government took office in 2010. Bank of England Governor Mervyn King said last month it may be “acceptable” for Osborne to miss the debt goal if there is a genuine excuse.
Only economist Philip Rush at Nomura International Plc in London said Osborne should introduce further cuts rather than ditch the debt target.
Balance of Risks
The survey was almost as conclusive in forecasting how financial markets would react, with 13 of the 18 economists saying further austerity would unsettle investors more than allowing some slippage in the debt target. Three said missing the target would hurt gilts and jeopardize Britain’s top credit rating, while giving a boost to equities and the pound.
“If the chancellor sticks to the existing fiscal consolidation path the economy will probably stay weak anyway and the deficit slippage would probably cause the U.K. to miss its debt rule,” said Michael Saunders, chief European economist at Citigroup Inc. in London. The U.K. “may well lose its top-notch credit rating.”
Osborne is due to make a statement to Parliament on Dec. 5 after receiving revised fiscal and economic forecasts from the Office for Budget Responsibility. The fiscal watchdog will say whether he has a realistic chance of meeting the debt target. In March, the OBR predicted debt would peak at 76.3 percent of gross domestic product in 2014-15 and begin falling the following year.
Osborne would have to decide whether letting the target slip would scare investors and drive up borrowing costs or be seen as a sensible move given the fragility of the economy.
Last year, Osborne was forced to announce an additional 23 billion pounds ($37 billion) of spending cuts and extend his plan to balance the budget by two years, meaning austerity will continue well beyond the next general election in 2015.
The U.K. economy has fared far worse than the government predicted and is set to shrink this year for the first time since 2009 as budget cuts bite and the euro-region crisis hits demand in the biggest market for British exports.
GDP shrank 0.4 percent between April and June, the third consecutive quarter of contraction. Weak tax revenue left the budget deficit in the first five months of the fiscal year 20 percent higher than a year earlier, putting Osborne on course to miss his full-year target of 120 billion pounds, according to economists.
The dilemma facing Osborne was underscored when Fitch Ratings said on Sept. 28 the country faces an increased risk of losing its AAA rating. It predicted government debt will peak at a higher level and later than it previously thought.
Deficit-reduction efforts are “standing still” and the pound could come under pressure if investors lose confidence in the fiscal plans and the economic recovery, Fitch Managing Director David Riley said.