16 September 2024
If you are covering the latest news in financial markets, please see the following comment from Lindsay James, investment strategist at Quilter Investors:
"Conversations about the UK economy often revolve around two main issues: the low rate of growth and the high level of debt. These two factors frequently clash due to fiscal rules requiring that debt as a share of GDP must be falling between the fourth and fifth year of the government’s spending forecasts.
"Economists argue that thee rules unfairly penalise spending when GDP growth is low. In a low growth economy, the slower growth of tax revenues means that to meet the spending rules, investment is usually the first area to face cuts. This, in turn, further weakens GDP growth.
"The UK faces a particular problem with weak labour productivity –the value of economic output per unit of labour. It has been blamed on numerous factors, but skills shortages, a lack of technology investment, slow and bureaucratic planning approvals, and transport infrastructure issues for commuters are among the most obvious. Investment directed effectively can help address these issues and boost GDP growth, but it still needs to be paid for.
"The Office for Budget Responsibility (OBR) has warned that UK debt is on an unsustainable path. Without significant tax rises or spending cuts every decade, the country faces a “spiral” of public debt. The OBR forecasts that debt could grow from 100% of GDP currently to 274% of GDP in 50 years’ time. Such a level would be unsustainable, as bond investors would stop buying gilts, sterling would collapse, and the IMF would be on speed-dial.
"Therefore, there is little choice but to invest in growing our economy at a faster rate. Without this we simply won’t ‘make ends meet’ as tax revenues won’t keep up with spending requirements. This means boosting government investment and supporting for private sector investment through the tax code and a favourable business environment.
"The challenge lies in gaining the support of bond markets. Investors are generally more supportive of investment for growth than they are seeing debt increase to fund tax cuts or day-to-day spending. Investment must be ruthlessly linked to economic growth outcomes. If market confidence in the UK’s ability to manage its debts evaporates, we could see a repeat of the Liz Truss mini-budget fiasco.
"Rachel Reeves has set herself two fiscal rules that will be monitored by the OBR: a requirement that the current budget, which excludes investment, moves into balance; and that debt falls as a share of the economy by the fifth year of the forecast. However, she has yet to fully flesh out the details of either of those rules — decisions that will have a huge impact on the amount of tax she needs to raise.
"Investors are used to these rules changing. In the past nine years there have been six sets of targets. Each of these was intended to guide policy for the following three to five years – but on average, each lasted less than 18 months."
