UK tries to juice its economy once again as banking storm clouds gather | CNN Business

London
CNN
 — 

UK financial markets were spooked again Wednesday — although, unlike last fall, the turmoil was unrelated to a new government budget aimed at reversing Britain’s economic decline.

UK finance minister Jeremy Hunt was careful to avoid the drama that engulfed his predecessor’s September “mini” budget as he laid out new spending and tax plans Wednesday. But as a crash in Credit Suisse

(CS) shares reignited fears triggered last week by the collapse of Silicon Valley Bank, the FTSE 100

(UKX) sank and the pound fell against the US dollar.

Fortunately for Hunt, the economic picture has improved a little since he scrapped most of the disastrous plans for debt-fueled tax cuts and a spending binge presented by previous chancellor Kwasi Kwarteng. Falling natural gas prices have taken some heat out of inflation, while providing a boost to government finances strained by energy subsidies for households.

The Office for Budget Responsibility (OBR), the government’s fiscal watchdog, now expects the UK economy to shrink by just 0.2% in 2023, compared with the 1.4% fall it predicted in November.

Still, the United Kingdom is the only major economy that the International Monetary Fund forecasts will contract this year; inflation continues to erode pay, worsening a longstanding decline in living standards; supply chains remain fragile; and the country is experiencing the worst wave of strike action in 30 years.

Financial market turbulence could make matters worse, if UK banks respond by extending less credit to households and businesses, weighing on consumer demand and investment spending.

More than 133,000 civil servants were due to walk out over pay, pensions and job security Wednesday, joined by teachers, transport workers, junior doctors and some BBCs journalists.

Some economists thought Hunt might boost public sector pay to put an end to rolling strikes. But he made only a passing reference to “industrial strife,” even though the economy lost nearly 2.5 million working days to strikes between June and December.

Hunt did, however, pledge to extend government support for energy costs, keeping in place a £2,500 ($3,037) cap on annual bills until the end of June, which will save the average family £160 ($193).

He also unveiled plans to boost business investment and grow the workforce. These measures “should be pro-growth,” said chief economic adviser to the EY ITEM Club, Martin Beck. “Although whether they will lift the UK out of a long period of slow expansion appears debatable.”

Despite a laundry list of challenges facing the UK economy — from Brexit and labor shortages to striking workers and a crumbling public health system — Hunt rejected the “narrative of decline.”

“In the autumn we took difficult decisions to deliver stability and sound money. Today, we deliver the next part of our plan: a budget for growth,” he said.

“Not just growth from emerging out of a downturn. But long-term, sustainable, healthy growth… all whilst making our country one of the most prosperous in the world.”

Britain is the only G7 economy yet to regain its pre-pandemic size, and a lack of investment is partly to blame.

As part of his bid to balance the books, Hunt stuck with plans to hike corporation tax from 19% to 25% come April, noting that the United Kingdom would still have the lowest headline rate in the G7.

But to lift growth and tackle low levels of business investment, Hunt unveiled tax breaks that will allow companies to offset every pound invested in equipment, plant and machinery against taxable profits for the next three years. The OBR expects this will increase business investment by 3% for every year it is in place.

Labor shortages are also a huge constraint on economic growth, and Hunt announced a raft of measures to encourage parents, retirees and those with disabilities or in poor health back into work.

There are currently more than 1 million vacancies in the UK economy, about 300,000 more than before the pandemic, and 21% of the working population is “economically inactive,” according to the Office for National Statistics, meaning they are unemployed and not looking for work.

Alongside Brexit, early retirement and ill health are major factors. Some 3.5 million people between the ages of 50 and 65 are not part of the labor force, according to Hunt.

In one of the biggest budget giveaways, Hunt introduced 30 hours of weekly free childcare for working parents with children over nine months, to be implemented in stages from April 2024 to September 2025. The chancellor said the measure would reduce childcare costs by 60%, saving families £6,500 ($7,800) a year.

To encourage people over 50 to extend their careers, Hunt increased the annual tax-free allowance for pension contributions by 50% to £60,000 ($72,360) and scrapped the £1 million ($1.2 million) “lifetime allowance” on tax-free pension contributions, which penalized workers with larger pension savings and which has been cited by some doctors as a reason for retiring early.

While the prospects for the UK economy look brighter than in the fall, the sudden collapse of Silicon Valley Bank could weigh on growth in the near term.

Issues in the US banking sector present “a new source of uncertainty” and “some unexpected caution may need to be attached to the OBR’s less downbeat forecasts,” Beck of the EY ITEM Club said in a note Wednesday.

The collapse of SVB continued to reverberate through global financial markets Wednesday, pummeling banking stocks, including in the United Kingdom where financial services still play an outsized role in the economy.

Although the selloff is not expected to cause a broader banking meltdown, it will make lenders more cautious, which could have significant implications, according to Berenberg’s senior economist, Kallum Pickering.

“It is likely that UK financial conditions will remain tighter (or potentially significantly tighter) over coming months than they would have been without the US banking troubles,” Pickering said in a research note Monday. “All else equal, tighter financial conditions will weigh on consumer demand and reduce the availability of credit for investment spending.”

If banks reprice or reduce lending, that may make the UK recession “a touch bigger” than the 1% decline Capital Economics expects this year, said the firm’s chief UK economist, Paul Dales.

“But as it stands at the moment, it doesn’t look as though a repeat of the global financial crisis is on the cards, during which UK real GDP fell by 6%,” he added.