UK budget hole of £30bn could threaten Reeves’ plans – BNN Bloomberg

(Bloomberg) — Chancellor of the Exchequer Rachel Reeves is facing a budget hole of 30 billion pounds ($39 billion), which could make it harder for the new U.K. government to fix the country’s ailing public services.

The Office for Budget Responsibility’s forecasts for economic growth over the next two years are overly optimistic and any moves by Labour to boost growth could be undermined by ratings downgrades, private sector economists say.

While the OBR, the fiscal watchdog whose forecasts underpin the government’s budget plans, predicts growth of 1.9% in 2025, an average of 56 economists surveyed by Bloomberg puts it at a more modest 1.3%.

“The changes forecast by the OBR could easily offset any boost to growth from government policies such as housing or the small changes to EU trade relations that Labour appears to be planning,” Robert Wood, chief UK economist at Pantheon Macroeconomics, said in an interview with Bloomberg.

The warnings expose the fragility of public finances as the new Labour government seeks to boost economic growth to generate extra money to fund ailing essential services.

Labour will be hoping to build on what has been an impressive recovery from last year’s recession. New data on Thursday showed the economy grew twice as fast as expected in May, putting Britain on course for another strong expansion in the second quarter.

Although Prime Minister Keir Starmer has ruled out a return to austerity, his government will need to either borrow more, raise taxes or boost growth to mitigate the spending cuts planned by the previous government if it is to stick to its own fiscal rules.

The situation is further complicated by the fact that former Conservative Chancellor of the Exchequer Jeremy Hunt allocated himself an extremely modest financial allocation of just £9 billion in his March Budget, even though Office for the Budget (OBR) forecasts had already predicted an acceleration in economic growth.

“Labor will need to deliver well on its growth measures to stop our already minimal potential from shrinking any further,” Wood said.

In an attempt to lower expectations of what Labour can achieve now, Reeves has already said it has inherited the worst public finances since the Second World War, while Starmer gave a taste of the damage his government is trying to repair by saying late on Wednesday that the country’s prisons were in a worse state than he had predicted and that Labour would have to follow the Tory plan to release some prisoners early.

On Monday, Reeves said the task of reviving Britain’s sluggish growth rates was a “national mission” for the Labour government after a poor economic performance since the financial crisis. The new administration aims to boost growth to the highest level among the Group of Seven economies through higher investment and rapid supply-side reform, including a major overhaul of the planning system.

City of London forecasters fear the OBR is particularly optimistic about a return to faster productivity growth, a prediction that was repeated in the 2010s and never came true.

Pantheon’s Wood predicts the government will borrow £30bn ($39bn) more in 2028/29 if productivity growth is weaker than expected and worker participation rates continue to deteriorate. But he said he did not expect the OBR to cut its potential growth forecast that much in the autumn, given its optimism about productivity in the past.

Salman Ahmed, global head of macroeconomics and strategic asset allocation at Fidelity International, warned that pressure on fiscal plans could take 12 to 18 months.

“If economic growth in the next fiscal year (and beyond) is significantly below 2% and more in line with the consensus or the Bank of England forecast of around 1.25%, there will suddenly be a budget gap of £20-30 billion, which could cause problems for policymakers,” Ahmed said.

The OBR further forecast growth of 2% in 2026, compared with 1.4% forecast by a smaller sample of 21 economists. Some warned that pressure on Reeves could come as early as the autumn.

Estimates from Citigroup’s chief UK economist, Ben Nabarro, suggest that financial market movements since the last forecast could result in losses of around £16bn, if the OBR cuts its “optimistic” productivity forecast by 10-20 basis points in the autumn. That would wipe out gains in other areas, such as generating extra revenue from moving the forecast forward by a year.

“That would still be a near-record low in terms of overall room to maneuver,” he said.

(GDP data for May updated in sixth paragraph.)