Reeves fiscal rule change puts economy in danger of ‘crumbling’, City analyst warns
The UK economy is in danger of “crumbling” as a result of the Chancellor’s likely changes to the fiscal rules, according to a City advisory firm.
Rachel Reeves confirmed last week that she will reform the fiscal rules to free up tens of billions of extra investment spending over the course of the parliament.
However, a number of City commentators have sounded the alarm about the change and its potential impact on the economy.
“Tinkering with the definition of borrowing could be a big, if temporary, win,” Nick Winters, a partner at tax accounting and avisory firm Blick Rothenburg, said.
“This proposal gives the impression that Labour is tweaking a large spreadsheet to attempt to meet all of their promises. But unlike a spreadsheet, there are only so many tweaks our economy can take before it crumbles,” he added.
Winters pointed out that government bond yields – the interest rate on government debt – had increased significantly over recent weeks while yields on other sovereign bonds had decreased.
At the end of last week the yield on the 10-year Gilt stood at its highest level in 16 weeks while the spread against the German Bund was at its highest level in over a year.
Winters suggested this was because markets had been “spooked” by rumours of the fiscal rule change. Under the new fiscal rules, the government will aim to get public sector net financial liabilities (PSNFL) falling in five years time rather than public sector net debt.
PSNFL differs by including the value of financial assets held by the government, such as student loans and stakes in private businesses held by government-owned investment vehicles.
The change would give Reeves space to borrow an additional £50bn a year by the end of the decade, according to official forecasts made in March, though the government is very unlikely to use all of this extra fiscal headroom in one go.
In an interview with the Observer, Reeves claimed that greater investment was needed in order to stave off economic “decline”.
“We inherited a plan from the previous government in which public sector net investment, capital investment, would be falling sharply over the course of this parliament,” she said.
“That would mean scores of hospitals not built. It would mean massive opportunities to grow our economy in the digital and energy sector would be missed and those jobs would go elsewhere”.
However, Andrew Griffith, former City minister, accused the Chancellor of “breaking promises like a runaway horse charging through the jumps in the Grand National”.
Labour committed in its manifesto to get debt falling in as a share of the economy by the fifth year of the forecast, although it did not specify which measure of debt it would use.
“Fiddling the books on debt today means its the next generation who will pay the price,” Griffith argued.
Allan Monks, an economist at JP Morgan, warned that the changes might enable “almost limitless spending” through institutions like the National Wealth Fund.
This is because lending through off-balance sheet vehicles would create illiquid financial assets, which could be netted off against the additional borrowing undertaken to fund the lending in the first place.
“This raises the prospect of a change back to a ‘PFI-type’ world of the early 2000s, where gilt borrowing increases in order to on-lend funds to off balance sheet entities which then lend[or] invest in public projects,” analysts at Barclays said.