Any move by UK Chancellor of the Exchequer Jeremy Hunt to cut taxes in next month’s annual budget could backfire by reversing the recent fall in mortgage rates and inflicting more pain on households if markets fear the giveaway will reignite inflation, Bloomberg Economics warned.
Hunt and Prime Minister Rishi Sunak have made no secret of their ambition to cut taxes at the budget on March 6, but the chancellor has stressed he will only do so if the move is compatible with his fiscal rules.
Bloomberg’s senior UK economist, Dan Hanson, said Tuesday that Hunt must also be careful not to undermine the Bank of England’s efforts to tame prices.
Beyond finding the money, “the more immediate challenge will be to deliver sweeteners for voters that don’t cause the BOE to rethink the merits of reducing interest rates this year,” Hanson said. “A policy package that ends up lifting mortgage rates is the last thing Hunt will want with an election looming.”
The analysis underscores the tricky balance the governing Conservatives must strike as they seek to overturn a 20-point polling deficit to the opposition Labour Party with less than a year before British voters go to the polls in a general election.
No date has yet been set for the vote, but Sunak must hold it before the end of January 2025.
Households have only just started to see living standards improve as the UK emerges from the inflation shock of the past two years, but their finances are highly sensitive to mortgage rates.
The BOE warned in December that just under five million households face an average £2,900 ($3,700) increase in their annual mortgage payment as they roll off existing deals between the June 2023 and the end of 2026. Over 2 million must reset this year.
By comparison, a 2% cut in income tax would save someone on a salary of £50,000 around £800 a year.
Mortgage offers have improved since December as inflation has fallen and investors have priced in rate cuts for 2024.
Erik Britton, managing director of Fathom Consulting and a former Bank of England economist, said the chancellor needs to be careful as lower interest rates have a big effect on the economy.
A 1% cut in interest rates is equivalent to about £25 billion worth of fiscal loosening - about 4 percentage points off income tax, he said. “There’s probably a sweet spot with a little of each but it’s hard to judge.”
Simon French, chief UK economist at Panmure Gordon, warned that big increases in the minimum wage, pensions and benefits in April already threaten to be inflationary and the chancellor should be wary of doing “anything that risks amplifying that.”
The chancellor has recently downplayed expectations of a big tax giveaway. He said last month that “it doesn’t look to me like we will have the same scope for cutting taxes in the spring budget that we had in the Autumn Statement.”
When he unveiled that plan in November, Hunt had £31 billion of headroom, of which he spent £18 billion.
The Office for Budget Responsibility told the chancellor last month he has about £14 billion to spare against his fiscal rules but revised population projections since then may have increased his potential firepower, Bloomberg reported last week.
Hanson said Hunt could choose tax cuts that also improve the growth capacity of the economy, if he is to avoid sparking inflation concerns.
In November, the OBR said the chancellor’s 2% cut in National Insurance was growth-enhancing and non-inflationary. A repeat would potentially be preferable to a cut in income tax.
The chancellor could simply “use all the fiscal space he is given” but “the big drawback and reason to think Hunt wouldn’t take that path is it would risk the very thing he will want to avoid – an adverse market reaction,” Hanson said.
Hunt has signaled he is alert to the risk, saying he wants tax cuts that deliver “dynamic, faster-growing economies.”