The week ahead: An exercise in can kicking
24 March 2025
Chancellor Rachel Reeves will announce spending cuts of around £10bn in her Spring Statement this week in order to not break her fiscal rules. However, these cuts will largely be backloaded to 2030, meaning they won’t change the outlook for the economy or Bank of England over the next couple of years.
The bigger picture, though, is that further tax rises at some point are starting to look inevitable if things like defence spending are to rise. A combination of weaker-than-expected growth and higher interest costs (gilt yields have risen by about 50bps since the Autumn Budget) have likely wiped out the meagre £10bn headroom the chancellor left herself against the new fiscal targets.
Of course, the OBR forecast has many moving parts. It may be that the new, higher, population forecasts let her off the hook (more people means more taxes). And, remember, as far as the fiscal rules are concerned, it’s only the budget deficit in 2029-30 that matters. So, if the OBR downgrades its forecasts for this year, which seems almost certain, but assumes that lower growth now will be offset by faster growth in the future, then tax receipts will be unaffected. Our best guess is that the government’s fiscal position will probably be about £10bn worse off, meaning the chancellor will be in danger of breaching her fiscal rules.
That leaves her with three options for how to deal with it. She could rewrite the fiscal rules. These are the eighth set of fiscal rules the UK has had in the last ten years so clearly the rules are not set in stone. But what is the point of having rules if you just change them as soon as they start to bite? What’s more, altering them so soon after announcing them will undermine her credibility with financial markets and would probably lead to higher gilt yields, exacerbating the problem.
She could announce tax rises. But these would be politically unpopular and would be against all the Treasury communications of there now being just one fiscal event a year. If the chancellor does change tax policy, then the obvious move would be to extend the freeze in Income Tax and National Insurance thresholds for another two years, which would bring in about another £10bn by 2030.
The most likely response is to cut future spending. We already know recent changes to welfare should save about £5bn a year and there will probably be another £5bn reduction in future spending. As long as those cuts don’t come in until 2030, as seems likely, they won’t impact the economy over the next couple of years and therefore won’t change the outlook for interest rates.
The obvious challenge is that this is just another exercise in kicking the can down the road. Welfare spending looks to be on an unsustainable trajectory and if defence spending is to rise to 3% of GDP, or higher as many analysts suspect, then at some point taxes will have to rise or much bigger cuts in spending will have to come. If the government is lucky, then it will be able to kick this particular can into the next parliament. But at some point in the next few years, further tax rises are starting to look inevitable.
- Inflation stable
- Retail sales slow
Inflation stable
Headline CPI inflation should hold steady at 3% in February. However, the Bank of England (BoE) pencilled in 2.8% back in February.
It’s both core goods and food that are putting upwards pressure on inflation. Food surprised to the upside in January, rising to 3.3% from 2%. We think that will rise again. Core goods inflation is likely to rise to 1.8% from 1.6%.
Services inflation, which is a key metric for the BoE because it is much more reflective of domestic price pressures, should fall to 4.8% from 5%. That would take it below the Bank’s forecast of 5.1%.
Higher energy prices and large increases in administered prices (those set internally by a firm based on cost and not supply and demand in the market), are likely to drive inflation back up in the next quarter or so. We expect a peak of 3.7% in September. However, services inflation should slow down further, coming in below 4.5%.
The BoE has assumed the rise in headline inflation won’t feed through into higher wage demands. That would help price pressures to keep moderating. The risk here is that inflation expectations are less anchored than the BoE believes and workers demand bigger pay rises, which could prompt a more worrying rise in inflation.
Retail sales slow
Retail sales probably fell 0.4% after a big jump of 1.7% in January.
This is because many consumers are still feeling the hangover from the cost-of-living crisis. Yet pressure on domestic finances should be easing as wage growth continues to outpace inflation, leaving more cash in people’s pockets.
Still, inflation remains above target. The energy price cap will also increase by 6.4% on 1 April. This may prompt consumers to remain cautious. Consumer confidence remains below its ten-year average, despite rising real wages.
Households are clearly missing a reason to feel confident about the future, prompting them to save, not spend, increases in wages, especially as interest rates remain higher than they have been in recent years.
The large rise in the National Minimum Wage should bolster retailers going forward. People on lower incomes tend to spend a bigger proportion of their pay increases to meet unfulfilled needs and maintain living standards. Meanwhile, interest rates should keep coming down, easing the burden on households.
Sign up to our for regular commentary and analysis from Tom on the changing economic landscape.
UK quarterly economic outlook
Subscribe to The Real Economy
Related insights
Strong pay growth means no MPC cut
20 Mar 2025
