Rishi Sunak already has experience of managing Britain’s public finances through a crisis, but that is unlikely to make tackling the country’s economic challenges any less daunting.
As Chancellor of the Exchequer from February 2020 to July, Mr Sunak spent heavily to protect households and businesses from some of the economic fallout from the coronavirus pandemic. At the time, inflation was low and the Bank of England was buying public debt, helping to keep interest rates low as borrowing ballooned to pay for the sharp increase in spending.
Now Mr Sunak, who is set to be Britain’s next Prime Minister after being named leader of the Conservative Party on Monday, will face a very different economic backdrop: the inflation rate has topped 10%, the highest in 40 years and , like many countries, the economy is slowing down and risks falling into recession. Meanwhile, the Bank of England continues to raise interest rates to curb inflation and won’t be there to buy government debt as from next month it plans to slowly sell its bond holdings . This means that the government will rely more on investors, who have demanded higher interest rates, than on the central bank to buy bonds.
Under these circumstances, Mr. Sunak has several pressing issues to address. One is how to support households squeezed by rising energy costs, after Russia’s war in Ukraine introduced huge volatility to global energy markets. As it stands, household bills have been frozen from this month to April at an average of 2,500 pounds ($2,826) a year, but after that the government is expected to develop a cheaper policy to help most vulnerable households. A similar policy is in place to help businesses for six months.
After setting aside tens of billions of pounds to cut energy bills, the government is also under pressure to show how it will continue to borrow under control, in a bid to restore Britain’s fiscal credibility on markets. Jeremy Hunt, the finance minister recently installed by Liz Truss but a supporter of Mr Sunak, is due to present a budget statement on October 31 which he says will show Britain’s debt falling as a percentage of national income over the medium term.
To reduce debt levels, “stunningly difficult decisions” on spending and taxes will have to be made, Mr Hunt said. He said he would ask every government department to find ways to save money despite their already stretched budgets. At the same time, Mr Hunt said taxes were also likely to rise. Mr Sunak, however, is not obligated to keep Mr Hunt as chancellor or stick to the current timetable for the budget statement, although many analysts expect him to do so.
“The UK is a great country, but there is no doubt that we face a profound economic challenge,” Mr Sunak said in a brief speech on Monday. “Now we need stability and unity.”
At this stage, Mr Sunak has not revealed details of his economic plan as prime minister, but investors appear to be accepting the prospect of his premiership with enthusiasm.
The pound is trading at around $1.13, slightly higher than it was on September 22 before Ms Truss’ tax cut plan shook markets, pushing the pound lower and costs higher borrowing. Government bond yields have fallen from their recent highs. On Monday afternoon, the 10-year bond yield was around 3.75%, after closing at 4% on Friday. It is the lowest level since Ms Truss’ government financial statement in September.
Lower interest rates will be a comfort to Mr. Sunak. On the one hand, lower rates will reduce the amount of money the Treasury will have to set aside for interest rate payments, which could facilitate spending cuts and tax increases. But there are other reminders of the economic difficulties facing Britain.
A measure of economic activity in Britain fell on Monday, with the services sector posting its worst monthly decline since January 2021, according to the Purchasing Managers’ Index, which measures economic trends. The services and manufacturing activity index fell to 47.2 points. A reading below 50 signifies a contraction in activity.
The data showed the pace of economic decline was accelerating, said Chris Williamson, economist at S&P Global Market Intelligence.
And on Friday, credit rating agency Moody’s changed its outlook on Britain to negative, from stable, while reaffirming the country’s current Aa3 investment rating. A lower credit rating tends to result in higher borrowing costs for the government.
Moody’s said the outlook had turned negative due to “increased unpredictability in policy-making amid weaker growth prospects and high inflation.” There was also a risk that increased borrowing would challenge the affordability of UK debt, especially if there was a “sustained weakening of political credibility”.
These are just the latest in a long list of government economic concerns. These include supporting low-income households against the rising cost of living, encouraging investment to improve weak productivity growth, smoothing Britain’s trade relationship with the European Union and developing the labor market to ensure businesses can find people with the right skills.
“We need a clear long-term vision of how the new Prime Minister will meet the challenges ahead,” said Shevaun Haviland, chief executive of the UK Chambers of Commerce, “and create the business conditions that enable businesses, and the communities that depend on them, to thrive.