Widening UK budget deficit hands Hammond a headache

Britain’s budget deficit unexpectedly widened in October, handing Philip Hammond disappointing news on the eve of the budget.

Public sector net borrowing last month, excluding the nationalised banks, grew by £500m to £8bn compared with October a year ago, according to the Office for National Statistics (ONS). City economists expected the deficit, which is the gap between government spending and tax receipts, to improve by £500m to stand at £7bn.

The figures are likely to frustrate the chancellor as he puts the final touches to his budget speech – due to be delivered around 12.30.pm on Wednesday – as they point to a weaker picture than thought for the public finances. Hammond is coming under increasing pressure, including from senior Conservative figures, to increase spending amid widespread dissatisfaction with austerity.

The chancellor is also expected to see his room for manoeuvre drastically reduced on Wednesday by the Office for Budget Responsibility, the government’s economic forecaster, which is expected to downgrade the outlook for the public finances due to weaker levels of productivity. Lower expectations for the output per worker will have an impact on gross domestic product, cutting the amount of economic output available for taxation.

The Institute for Fiscal Studies reckons the downgrade will contribute to a £20bn black hole in the public finances, limiting Hammond’s spending power if he wants to stick to his pledge to remove the deficit by the mid 2020s.

John McDonnell, the Labour shadow chancellor, seized on the wider than expected deficit in October to argue that seven years of spending cuts had “caused pain and misery for millions with little to show for it”.

“It further highlights why it is so vital that we see a change of course in the budget tomorrow, halting the growing emergency in our public services and ending their failed austerity policies,” he added.

Howard Archer, chief economic adviser to the EY Item Club, said: “Wednesday’s budget is not going to be easy for the chancellor … he now faces larger deficits over the medium-term due to the OBR downgrading its productivity growth forecasts for the UK and he has to square the circle.”

The unexpected increase in the deficit in October was fuelled by higher debt interest payments on government bonds due to rising inflation. Some gilts, which are bonds sold by the government to investors for financing the running of the country, are linked to the retail price index (RPI) measure of inflation.

The depreciation in the value of the pound since the Brexit vote a year ago has caused inflation to soar, with the RPI hitting 4% in October – the highest level since December 2011. The government paid £6bn in debt interest last month, which was the highest amount ever paid for any October on record, although it fell short of the biggest ever monthly payment of £7.2bn, which came in April 2017.

Despite the deterioration last month, the general trend for the public finances is one of improvement. Hammond is likely to seize upon the borrowing figure for the year so far, which the ONS said was the smallest deficit since 2007.

The deficit in the first seven months of 2017 since the financial year began in April fell by £4.1bn to £38.5bn compared with the same period in 2016. The lower levels of borrowing mean the chancellor is likely to undershoot the OBR’s March forecast for £58.3bn of borrowing during the financial year ending March 2018.

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