Osborne’s statement causes Fitch to review UK rating

Yesterdays Autumn Statement by the chancellor, George Osborne, threw the opposition by suggesting that despite the government missing it’s targets and that the national deficit was set to fall more slowly than predicted, the statement was fiscally neutral – with some unexpected cash for those in work and driving a car.

Osborne appeared un-phased as he announced that the Office for Budgetary Responsibility(OBR)  had forecast that the UK economy over 2012 would remain in recession with growth of -0.1%, but the OBR put this continued decline down to external factors – not government policy.  Osborne in fact forecast that his policy would deliver the Government targets, but not until 2018 and only by increasing borrowing by a further £100 billion.  However going forwards Osborne forecast reducing borrowing at the rate of 1% over the following three years, more importantly it was going to to fall as a proportion of GDP – which is the acid test for the health of the economy. Currently borrowing stands at 80% of GDP – but is forecast to fall to 77.3% of GDP by 2018, resulting in austerity measures being  retained for longer than originally predicted.

It was this failure to hit targets and the continuing austerity to 2018 that prompted the rating agency Fitch to announce this morning that it will be reviewing the UKs triple A status.  If this results in a down grading and the UK loosing the coveted triple A rating the cost of borrowing for the government will go up potentially pushing the economy into spiral of decline.

Why is the economy is such a state?

The OBR cited three external factors which had led to the continuing economic problems:

  • The impact of the international financial crisis on GDP had been greater than predicted
  • The Euro crisis had damaged confidence in the UK economy and
  • inflation in commodity prices had reduced profits and increased costs

Absolved of responsibility the chancellor seemed almost happy with the situation and saw no reason to change his policies stating that any change from the policy of austerity would do more damage. However clearly the policy is not creating the key factor for the economy growth.

Irrespective of their stripe all commentators agree that there is only one way out of the problems – that is through growth, but it is how that growth is created where economists and politicians cannot agree.

The stumbling block is public spending – does public or government spending increase or decrease the money supply?

All public spending is at the end derived from taxation which reduces the money in everyone’s pocket – so reduces the demand in the economy and therefore growth.  If in the short term government spending is funded by borrowing then the resulting taxation has to raise not only the principle but also the interest – so eventually resulting in higher taxes.

To counter this argument Keynes argued that there was a multiplier effect, this meant that by increasing government spending the resulting activity in the economy was far greater and this increase resulted in a greater tax take which more than compensated for the cost of borrowing. It was this approach that resolved the problems in the US economy in the 1930s when unemployment was out of control.



Interestingly employment figures for the UK  would suggest that there was not a problem in the UK until you look below the headline figures.  Unlike the US in the 1930s today in the UK there are people in work who are also claiming benefit – it is suggested that the growth in poverty is actually in the employed with many families relying on tax credits to survive on low wages or part-time employment.

More importantly labour politicians would argue that taxation and government spending is also redistributive taking money from one part of the economy to another – most often to alleviate poverty and to provide welfare for the less fortunate but also to promote what is seen as ‘a good thing’ such as green energy.

Giving and taking

Osborne has actually done a little of both despite the figures suggesting the economy was still flatlining.   Measures to increase the money in the economy

  • reducing income tax,
  • cutting corporation tax
  • cancelling the planned increase in fuel tax
  • increasing tax relief on capital spending for business
  • £5bn of government spending on infrastructure projects
However these will be paid for by other measures
  • Cuts in departmental budgets of 1%
  • increase in the bank levy rate to 0.13%
  • £3bn in extra taxes collected from businesses and individuals avoiding UK taxes as well as by clamping down on fraud
  • Benefits capped to 1% pa growth
There is also an anticipation that the government will receive a windfall from the auction of 4G licenses which will ease the pressure.

Smoke and Mirrors – responses to the statement

There were also some changes which made the figures more difficult to get to grips with, not only the counting in of G sales but transfers from the Bank of England to the treasury will help reduce government borrowing in the short term,  this ‘slight of hand’ produced a faltering response from shadow chancellor Ed Balls, but this was really the only good  news for the government.

Balls was quick to point out that the statement hit the poorest hardest – a working family on £20, 00o would loose  £279 a year that they could ill afford.  The 1% cap on working age benefits would cause further hardship to those who have fewer opportunities. Ed Balls contrasted these approaches with that of the richest in the community who would benefit from a 1% cut in higher rate tax, suggesting that the poor cold only be motivated by the stick and the rich only motivated by the carrot reinforcing the oppositions argument that government policy was dividing the nation.

More importantly Balls suggested that government policy was dividing the UK from other key economies with the US econo,y achieving a growth rate of 2.7% and even with growth slowing in Europe  Germany and France achieved growth of 1.3% and 1.67% respectively*.


Clearly Osborne’s statement has not impressed the one group of people he has to – the rating agencies.  If Fitch does downgrade the UK the economy will be further  damaged  and even the review will not help.

The reduction of taxes has to be a positive step, however the promise of capital spending has been made before and as yet very little has materialised.  Similarly measures to promote lending to businesses have not worked, perhaps the step of offering relief on capital spending will be better.

I am concerned that welfare spending cuts already announced have yet to bite and those desperately trying to keep in work and raise a family will be forced into poverty.

Underlying everything is confidence – Fitch has had their confidence knocked, businesses have the cash but lack the confidence to invest, I do not think there is enough in this statement to give the people the confidence to spend their money and stimulate the economy – I am afraid only the government can do that.

I believe that borrowing to inject money into the economy as a stimulus through capital projects is the only answer – clearly the current measures have not cut borrowing, the government is having to borrow more to cover welfare spending and make up the shortfall in the tax take.

Download full statement here

Trading Economics

Analysis in the News

Key Points of the Statement in the Guardian on-line



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