UK economy in ‘horrible bind’ as recession looms with no room for tax cuts, say experts

The UK economy is in a “horrible fiscal bind” as it heads for recession with no room to cut taxes or increase public spending to offer a boost, an influential group of economists has said.

The Institute for Fiscal Studies (IFS) warned that Britain will slump into a “moderate” recession in the first half of 2024, as the struggle for growth remains while borrowing costs stay elevated.

It comes as the Bank of England’s chief economist warned that there was still “work to do” to bring UK inflation back under control – a hint that the base interest rate could rise yet again.

The IFS said there was little room for the tax cuts wanted by Tory MPs “any time soon”, in its “green budget” assessment of the nation’s public finances ahead of chancellor Jeremy Hunt’s autumn statement.

Using analysis by Citi, the IFS report warned that the UK would fall into a recession at the start of 2024 that will last for nine months. It also forecast that gross domestic product (GDP) would slump by 0.7 per cent next year.

“We are in a horrible fiscal bind,” said Paul Johnson, the director of the IFS. “The price of our high levels of indebtedness, failure to stimulate growth, and high borrowing costs is likely to be a protracted period of high taxes and tight spending.”

The IFS said there was no room for tax cuts or spending hikes despite a six-year freeze on income tax thresholds would mean an extra £52bn a year by 2027 – the equivalent of raising the basic and higher rate of income tax by 6p.

The amount raised by the “fiscal drag” process – pushes people into higher income tax brackets as pay increases – was “extraordinary”, said Paul Johnson, director of the IFS.

Labour said the so-called “stealth tax rise” showed that the Tories had “crashed the economy”. Darren Jones, shadow chief Treasury secretary, said: “Successive failures by Conservatives ministers have left us with low growth, high tax and national debt at the highest level in generations.”

Rishi Sunak’s government could come under pressure to increase public spending by more than planned, the IFS cautioned, as it offered a stark assessment of the situation a Labour government faces if it wins the 2024 general election.

Beyond March 2025, there are likely to be real-terms cuts to the day-to-day budgets of many governmental departments, and falling spending on investment in public services, the report said. It comes despite growing pressure to improve services such as the NHS, and to commit to spending in areas such as defence and childcare.

Government borrowing is also set to be around £20bn lower this year than the Office for Budget Responsibility (OBR) predicted in March. But debt levels have soared as borrowing costs have gone up, and the inflation rate remains above target.

In better news for the government, UK inflation according to the Consumer Prices Index is expected to drop to around 4.3 per cent by the end of the year – meaning that Mr Sunak would meet his promise to halve inflation by the end of December.

The IFS said that interest rates are set to remain above 5 per cent until mid-2024, when the Bank of England could begin steadily cutting rates. But the Bank faces its own challenge, of bringing down inflation while avoiding a deeper recession, which could be worsened by higher interest rates.

“The Monetary Policy Committee may want to wait for firm evidence of disinflation before it considers cutting rates. But by that point it might be too late, and the result could be a deep recession,” said the IFS.

The central bank’s chief economist, Huw Pill, said on Monday that there was more “work to do” to fight inflation, in a hint that the base rate could rise again from its current level of 5.25 per cent.

“We still have some work to do in order to get back to [the inflation target of 2 per cent],” he said. “And we probably have some work to do to ensure that, when we get back to 2 per cent, we do so in a way that is sustainable through time.”

Mr Pill – who said last week that the question of whether the Bank of England would need to raise interest rates further was “finely balanced” – said it was important “that we do not declare victory prematurely”.

Benjamin Nabarro, chief UK economist at Citi, said: “The lesson of the 1970s was to hold rates tight until you can see the ‘whites in the eyes’ of disinflation. In a highly financialised, debt-driven economy, that may turn out to be only half the story.”

The government said it was on track to get debt falling, and that it would not be deterred by changes to economic growth, inflation and interest rates. “To secure our public finances we must stick to our plan, which is on track to halve inflation, reduce public sector waste and get debt falling.”

Mr Hunt is due to present the 2023 autumn statement on 22 November, alongside an economic and fiscal forecast put together by the OBR.

In a gloomy assessment, Mr Hunt warned on Friday that he is “preparing for the worst” ahead of his autumn Budget, as the Israel-Hamas conflict and the ongoing war in Ukraine weigh on the global economy.