The UK is heading for its biggest ever current-year economic growth upgrade next week as a result of a smaller-than-forecast hit from the pandemic, and a faster-than-expected post-pandemic recovery, according to the Resolution Foundation.
The improvement in the UK's short-term fiscal position means chancellor Rishi Sunak will need to borrow up to £30bn less public spending2, the think thank's 'Uncertainty Principle' report published on Tuesday said
The pandemic required huge increases in government borrowing, but the faster-than-expected recovery means that borrowing will fall sharply. This means public borrowing is likely to be £20-30bn lower in 2021-22.
So far this year, public sector net borrowing has been £32bn below expectations, reflecting the improvements in the economy, the report said.
Smaller hit from pandemic and faster recovery also means the biggest ever upgrade to current year GDP forecasts in nearly 40 years of fiscal projections, with the economy set to grow by 7.5% in 2021.
Recent data, however, suggests that the country's economic recovery has slowed, with GDP rising by just 0.3% in July and August along with rising inflation.
However, the economic outlook for the rest of this fiscal year is less positive.
The annual borrowing improvement of up to £30bn this year is smaller than expected due to a record rise in the inflation forecast that will send borrowing costs up, the report said.
The impact of higher inflation and interest rates on debt-servicing costs are expected to add substantially to expenditure in 2021-22. Recent rises in interest rates could add around a further £2bn to annual borrowing by 2024-25, according to the report.
Inflation has risen from 0.4% in February to 3.2% in August and is predicted to hit 4% over the winter. Rising inflation is also set to reduce household incomes by £1,000 next year (relative to the the Office for Budget Responsibility's (OBR) forecast last March for inflation to fall through 2021).
The report also points to a "cost of living crunch" and calls on the chancellor to introduce new policies to relieve the pressure on family finances. Households will be feeling the crunch from rising energy bills, the £20 a week cut to universal credit, and a renewed pay squeeze over the winter if inflation overtakes pay growth, the report said.
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The Resolution Foundation said: "This updated economic outlook should enable the chancellor to meet his new fiscal rules of closing the deficit for day-to-spending and seeing debt fall as a share of the economy."
However, the report warns that Sunak may have little room for manoeuvre against these targets, especially when combined with the "hugely uncertain economic outlook" over the coming years.
The Resolution Foundation is calling on the government to create funding for public services outside of health, defence, education and overseas development (which together account for 60% of all day-to-day spending). Public services funding is set to be a fifth lower by the middle of the decade than they were in 2009-10, with the government having only reversed a third of cuts announced since then, according to the report.
James Smith, research director at the Resolution Foundation, said: “Following a regular whirlwind of fiscal announcements in just 18 months as chancellor, next week Rishi Sunak will finally get to deliver a Budget and Spending Review aiming to set a course for post-COVID Britain. But that doesn’t mean the choices he’ll face will be easy.
“The backdrop to the budget will be a strong recovery from the pandemic that risks being derailed by rising inflation and economic disruption that will squeeze both the Chancellor’s borrowing windfall and family budgets.
“The decisions that Rishi Sunak will take next Wednesday will help to define the rest of the parliament, and the type of chancellor he’ll be remembered as. But amid such long-term and legacy-defining announcements, he must not forget the cost of living crunch facing families up and down the country right now.”
Sunak is due to deliver the budget on 27 October.