Budget watchdogs warn another financial crisis would destroy government deficit plans

 
Jasper Jolly
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Theresa May Attends Prime Minister's Questions
Chancellor Philip Hammond is already expected to miss his target of balancing the books by 2025 (Source: Getty)

The government will miss its targets for reducing the spending deficit by “wide margins” if there is another big financial shock, the Treasury’s independent budget watchdog has warned.

In a report on the risks facing the UK economy, the Office for Budget Responsibility (OBR) today said a scenario similar to the financial crisis a decade ago would cause a big increase in government borrowing, although it also noted the outlook was clouded over by uncertainties over Brexit.

Using the same measures as the Bank of England stress tests, which presume a 4.7 per cent hit to GDP, the OBR found the deficit would be £158.5 billion higher by the 2021-22 fiscal year compared to the forecasts made at the time of the March budget.

Read more: Deficit lower than expected as healthy tax revenues give chancellor a boost

That would mean the chancellor, Philip Hammond, would be unable to bring the deficit below two per cent of GDP by 2021, with an even smaller chance of eliminating the deficit by 2025.

It would also mean the stock of public-sector debt, built up each year, would continue to rise. The government’s fiscal position is “more vulnerable” than before the crisis because of its debt load, which currently stands at 89.3 per cent of GDP, the report found.

Robert Chote, chairman of the OBR, said: “The nightmare scenario is one where the debt stock and debt interest payments get onto a trajectory where they would rise relentlessly as a share of GDP, ending in a full-blown fiscal crisis.”

“Pressures on public spending abound,” the OBR report said, with rising healthcare costs as the population ages and a new environment of “austerity fatigue”.

Read more: Deficit rises faster than expected in April as tax revenues stall

Since losing its majority at the last election the Conservative government has come under sustained pressure to raise spending from within its own party as well as from the opposition, with £1bn extra already committed to Northern Ireland in return for the support of the Democratic Unionist Party (DUP) in Parliament.

The OBR also warned persistent weakness in productivity growth, the ultimate driver of improved living standards, also looms over the British economy.

Chote said: “The most important long-term economic risk is weaker-than-expected growth in potential output.”

The OBR forecasts assume productivity growth finally accelerates back to pre-crisis levels, but it notes that lower growth in GDP per hour, the measure of productivity, of just 0.3 percentage points a year would wipe out half of Philip Hammond’s “fiscal headroom”.

“If the past few years prove to be the ‘new normal’, even the current challenging spending plans would require either higher taxes or higher borrowing,” Chote said.

Read more: Yes, austerity is a choice – but it's not an easy one

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