Experts Warn of ‘Dire Straits’ for UK Economy as Recession Looms, Limited Scope for Tax Reductions

 

In a sobering assessment, the Institute for Fiscal Studies (IFS) has declared that the UK economy is ensnared in a “distressing fiscal predicament,” leaving no room for tax cuts or increased public spending to provide a much-needed uplift. The influential group of economists predicts that Britain is poised for a “moderate” recession in the first half of 2024, with growth stifled and borrowing costs remaining high.

This assessment aligns with a cautionary note from the Bank of England’s chief economist, who emphasised that there is still significant “work to be done” in reining in UK inflation, suggesting a potential further rise in the base interest rate.

The IFS further stated that the desired tax cuts advocated by Tory MPs are unlikely to materialise “in the near future,” as outlined in their “green budget” evaluation of the nation’s public finances preceding Chancellor Jeremy Hunt’s autumn statement.

Citing analysis by Citi, the IFS report forewarns of a recession in early 2024, projected to persist for nine months, with a corresponding 0.7 per cent decline in gross domestic product (GDP) expected for the following year.

Director of the IFS, Paul Johnson, expressed the gravity of the situation, remarking, “We find ourselves in a challenging fiscal situation. The consequences of our elevated levels of debt, the struggle to stimulate growth, and the elevated costs of borrowing are likely to result in an extended period of high taxes and stringent spending.”

Despite a six-year freeze on income tax thresholds, which is set to generate an additional £52 billion annually by 2027, equivalent to a 6p rise in the basic and higher income tax rates, the IFS contends that there is no fiscal leeway. The revenue accrued through the “fiscal drag” mechanism, which pushes individuals into higher income tax brackets as their earnings increase, was described as “remarkable” by Paul Johnson, the director of the IFS.

The IFS also cautioned that Rishi Sunak’s government might face pressure to exceed planned levels of public spending, providing a stark assessment of the challenges a potential Labour government would confront if victorious in the 2024 general election.

In the aftermath of March 2025, numerous government departments are anticipated to face reductions in their day-to-day budgets, along with a decline in expenditure on public service investments, as per the report. This situation persists despite mounting pressure to enhance services like the NHS, and allocate funds towards defence and childcare.

Although government borrowing for this year is projected to be approximately £20 billion lower than what the Office for Budget Responsibility (OBR) initially forecasted in March, debt levels have surged due to increased borrowing costs and the inflation rate remaining above the target.

In more positive news for the government, the Consumer Prices Index indicates that UK inflation is projected to drop to around 4.3 per cent by year-end. This means that Mr. Sunak would fulfill his commitment to halve inflation by the end of December.

The Institute for Fiscal Studies (IFS) has indicated that interest rates are expected to stay above 5 per cent until mid-2024, at which point the Bank of England may begin a gradual reduction. However, the Bank faces its own challenge in reducing inflation without exacerbating a deeper recession, which could be compounded by higher interest rates.

The IFS remarked, “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.”

Huw Pill, the chief economist of the central bank, suggested on Monday that there is still more “work to do” in combating inflation, hinting at a potential rise from the current base rate of 5.25 per cent.

He stated, “We still have some work to do in order to get back to [the inflation target of 2 per cent], 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 mentioned last week that the decision on whether the Bank of England would need to further raise interest rates was “finely balanced,” emphasized the importance of not declaring victory prematurely.

Benjamin Nabarro, chief UK economist at Citi, remarked, “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 affirmed its commitment to bringing down debt and asserted that alterations in economic growth, inflation, and interest rates will not deter its efforts. They stated, “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 scheduled to present the 2023 autumn statement on 22 November, alongside an economic and fiscal forecast compiled by the OBR.

In a sombre evaluation, Mr. Hunt cautioned on Friday that he is “preparing for the worst” in advance of his autumn Budget, as the Israel-Hamas conflict and the ongoing war in Ukraine continue to exert pressure on the global economy.