Austerity until 2018 says UK Chancellor in his Budget, as Fitch warns AAA at risk

6 December 2012

According to the UK Chancellor, George Osborne, who laid out his budget yesterday for the UK economy “a hard road” lies ahead as he revised official growth forecasts downwards and explained he would have to borrow more and cut government spending still further to reduce the public deficit, with five more years of austerity measures promised. The Fitch Rating agency immediately warned the UK was at risk of losing its AAA credit rating.

Back in 2010 when Chancellor Osborne held his ‘emergency budget’ to map out the UK’s recovery from the banking crisis and recession, the new, grandly named, Office for Budget Responsibility (OBR) which was created to produce office forecasts, said it expected Britain’s recovery to be in full bloom by now, with 2.8% growth predicted this year, 2.9% next year, and an elimination of the structural deficit in the UK by the end of this Parliament in 2015. Instead, UK gross domestic product (GDP) actually shrank by 01% this year, which the government is blaming on the eurozone crisis, and an optimistic GDP growth forecast of just 1.2% is now being touted for next year, illustrating the depth of the ‘double dip’ recession in Britain.

The figures mean this is the weakest post-recession recovery since the end of the second world war in Britain and it has reiterated debate about whether it is better to invest government money in the economy to stimulate growth or to eliminate public debt quickly with the threat of inducing stagnation – all similar arguments to the ones recently heard in the US election and ‘fiscal cliff’ debates.

The UK Chancellor enacted his own ‘cliff’ measures yesterday by announcing more taxes for the rich, via the elimination of a £1bn pension tax relief grab, and deep cuts in welfare spending on the poor with £3.7bn being saved from the welfare bill by capping it at 1% growth over the next three years, a real-term cut as inflation continues to power ahead. More than 400,000 people will also be added to the 40% higher tax rate in the UK, to increase government revenues. The highest 50% tax rate was last year reduced to 45% for the most well-off in the country.

In terms of business, the announcement of a 1% cut in corporation tax to 21% will be welcomed, but it will not be positive to the bottom line of UK banks as the Chanellor has raised the specific bank levy to ensure banks - as public enemy number one - don't benefit. Apart from that there was not too much focus on the banking industry, as there has been in previous years' with no one-off bonus taxes aimed at the City and so forth. The government says it will continue to support and expand its 'funcing for lending' drive, however, which is administered via sometimes reluctant banks - as the failed project merlin scheme showed - iin an effort to support business growth. Corporation tax has been a fierce point of contention in the UK recently after a Parliamentary committee took Starbucks coffee to task for only paying corporation tax once in its 15 years of successful operation in the UK, position it has now reversed promising to pay £20m in tax until 2014.

The UK government mandated OBR is predicting that Britain’s national debt will not now start to fall until 2016-2017, instead of the original estimate of the end of this Parliament, and a surplus in the public purse of 0.9% is not now expected until 2018. The new UK austerity measures are designed to get the country to this point but could induce a ‘triple dip’ recession instead, particularly if the global economy continues to be in the doldrums. Despite this, Osborne insisted that: “Britain is on the right track and turning back now would be a disaster.”

Fitch Warns UK Could Lose AAA Rating
The credit rating agency (CRA), Fitch, warned immediately after Chancellor Osborne’s speech that his decision to delay the time until Britain’s national debt starts to fall, against its GDP figures, until 2016-17 was risky.

“In our view, missing he target [for eliminating the structural deficit] weakens the creditability of the UK’s fiscal framework, which is one of the factors supports its rating,” explained the CRA. Fitch had already placed the UK's AAA rating on Negative Outlook in March 2012. The CRA says it will conduct a further formal review in 2013, incorporating the government's latest budget.

“The government's ‘fiscal mandate’ requires it to balance the cyclically adjusted current balance over a five-year rolling period,” continued Fitch in its budget response. “The OBR's assessment is that the mandate will now be met in fiscal year 2016-17. This is in line with our own expectations, though the government is pushing an increasing part of the consolidation into the next parliamentary term.”

Fitch added that it expects more clarity about the UK government’s finances after next year's more comprehensive Spending Review.

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