Soaring energy prices and inflation threaten to tip the UK into recession while government debt levels could more than treble unless taxes are hiked, the UK fiscal watchdog has warned.
The Office for Budget Responsibility (OBR) said the UK Government has already spent as much this year, 1.25% of GDP, to help households cope with the cost-of-living crisis as it did supporting the economy through the financial crisis.
In its fiscal risks and sustainability report, the OBR predicts that debt could rise to over 100% of GDP by 2052-53 and reach 267% of GDP in 50 years if upward pressures on health, pensions and social care spending, and the loss of motoring taxes, are factored in.
Many threats remain, with rising inflation potentially tipping the economy into recession, continued uncertainty about our future trading relationship with the EU, a resurgence in Covid cases, a changing global climate, and rising interest rates all continuing to hang over the fiscal outlook
Office for Budget Responsibility
But it warned that debt could jump by nearly 320% in 50 years’ time, with future shocks taken into account and without fiscal policy being tightened.
The OBR said bringing debt back to 75% of GDP, the level at which it stabilised in the Government’s pre-pandemic March 2020 Budget, “would need taxes to rise, spending to fall, or a combination of both”.
This would amount to 1.5% of GDP, or £37 billion a year, of additional tightening at the beginning of each decade over the next 50 years, its report showed.
It also outlined energy price scenarios and their impact on the economy over the next two years, cautioning that if energy prices spike temporarily higher again next year, then inflation would reach 11% in the third quarter of 2023 and push the economy into a recession, as defined by two consecutive quarters of falling output.
The OBR said this scenario would see gross domestic product (GDP) fall 4% below its baseline scenario with household finances dropping just over 4% after inflation, before the economy quickly recovers as energy prices fall.
Government measures to tackle the crisis would add £30 billion to public debt in 2023-24 and £63 billion by 2026-27, it estimated.
The OBR said if the Government it continues extending current support in this price spike scenario, then borrowing would surge by £40 billion in 2023-24.
In its “persistent shock” scenario, where energy prices surge and remain at high levels, the economy’s productive potential would be weighed on and public finances would be even more unsustainable.
It predicts this could see GDP suffer a 2% hit, the same impact as it expects the pandemic to have.
The OBR said the Ukraine war, soaring energy prices and long-term pressure on the nation’s finances “add up to a challenging outlook for this and future governments as they steer the public finances through inevitable future shocks”.
The OBR said: “Many threats remain, with rising inflation potentially tipping the economy into recession, continued uncertainty about our future trading relationship with the EU, a resurgence in Covid cases, a changing global climate, and rising interest rates all continuing to hang over the fiscal outlook.”
But it said the current energy price woes may not be as bad as that seen in the 1970s.
“While the oil crises of the 1970s saw global energy prices rise by a similar magnitude as we have seen in the wake of the pandemic and Russian invasion of Ukraine, there are reasons to believe that the overall impact on inflation, output, and unemployment will be less severe and less persistent this time around,” according to the OBR.