Autumn Budget 2021: a sunny outlook amidst gathering inflationary clouds

One of the themes of the media coverage running up to the Autumn Budget was the slickness of Rishi Sunak’s presentation. From the carefully choreographed photographs with his new dog, Nova, to the drip feeding of popular spending announcements in advance, the Chancellor proved himself, once again, to be one of the best political communicators in politics today.

The delivery of the Budget speech reminded me of the Great Communicator himself, Ronald Reagan. The 40th President of the United States was known for his persistently optimistic and upbeat tone, and Sunak opened his statement by declaring that Britain can start looking beyond Covid to “an economy fit for a new age of optimism”, pledging to build a long-term higher-wage, higher-skilled economy.

Sunak touched on all the Government’s key themes except one. Levelling up was a running thread, Tees Valley got an obligatory shout-out, policy changes enabled by Britain leaving the EU were highlighted, and the Union was defended, but, curiously, COP26 wasn’t mentioned. Indeed, the reduction of Air Passenger Duty on internal UK flights and the freezing of Fuel Duty struck a slightly dissonant note. But the Chancellor understands the public well: increasing the living wage to £9.50, reducing the Universal Credit taper to 55% (from 63%) and – yes – freezing Fuel Duty and reducing the cost of a pint, will all be well received by voters.

And there was a big emphasis on spending. A very big emphasis on spending. Whilst rightly reminding MPs that “This isn’t the Government’s money, it’s taxpayers’ money”, the Chancellor went on to outline an extremely generous Comprehensive Spending Review, including a real-term rise in spending for every single Government department, making the Conservatives “the real party of public services”. As several commentators noted, it was very reminiscent of a Gordon Brown Budget, entrenching the spending habits of the Covid era as the new normal, and reversing the so-called ‘austerity’ of the Cameron/Osborne years. But it remains to be seen whether, unlike the Brown years, this Government is able to guard against wasteful spending, and whether this level of public spending is sustainable. The tax take, for example, is forecast to rise sharply to 36.2% by 2026, despite being remarkably stable under many different Chancellors this century, never higher than 33.6% and never lower than 31.5%.

Whilst Sunak’s speech was relentlessly upbeat, it was not naive about the challenges facing the country. Keir Starmer’s absence from the chamber after a positive Covid test demonstrated that the pandemic is not yet behind us. And Sunak rightly addressed the elephant in the room: inflation. With inflation running at 3.1% in September and set to hit 4.4% next year (other economic forecasts predict it might rise even higher), the Chancellor reiterated the Bank of England’s objective of delivering “low and stable inflation”, which means all eyes will now turn to the forthcoming meetings of the Monetary Policy Committee.

Market expectations of inflation are the highest they’ve been since the Bank of England became independent in 1997, and an interest rate rise is expected before Christmas, perhaps not when the MPC meets on 4 November, but almost certainly when it meets on 16 December. And rising interest rates will, of course, hit both family finances (gradually, most mortgages are fixed) and government spending (immediately, with higher debt interest repayments).

The other monetary policy lever at the Bank of England’s disposal is its programme of quantitative easing, which was a crucial lifeline during the pandemic, particularly in the early stages. This time last year, Andrew Bailey was stressing the possibility of deflation, and the need to continue QE to guard against that threat. Now that we are beginning to see inflation emerge, the justification for central banks to print money disappears, which is why both the Federal Reserve and the European Central Bank are now scaling back their QE programmes. And as the Chancellor was speaking, the Canadian central bank also announced the end of QE and rolled the pitch for interest rate rises. But what will the Bank of England do? And is further QE required to cover the spending commitments in the Comprehensive Spending Review?

If inflation proves to be a temporary result of the world economy emerging from the pandemic, the numbers will probably stack up. But if it proves to be more persistent (and higher energy costs, taxes and wages feeding through into higher prices won’t help on this front), then further interest rate rises will become necessary, QE will have to end, and the optimistic forecasts in the Autumn Budget will rapidly become out of date.

Rishi Sunak gets this, which is why he has talked about the threat of inflation keeping him up at night. And he is right to be worried. Whilst it is welcome news from the Office for Budget Responsibility that the economy will return to its pre-Covid level by the end of the year (sooner than previously predicted), with economic growth this year and next year at 6.5% and 6%, respectively, the predictions for subsequent years of 2.1% and 1.3% look anaemic. How can this be addressed in future Budgets? A greater focus on productivity is essential and, learning from Ronald Reagan in another way, a much bigger emphasis on supply-side measures.

The tax system needs to encourage entrepreneurship, innovation and investment; the civil service needs to be reformed to ensure this additional money is well spent; the City of London needs to be restored as the world’s number one financial centre; and the extra investment in our schools and universities needs to be focused on creating the foundations for a knowledge-based economy. Those are all big agenda items to shoehorn into one Budget speech, but if we are truly going to achieve “an economy fit for a new age of optimism”, this Comprehensive Spending Review needs to mark the beginning, rather than the end, of the hard work.

Matthew Elliott tweets @matthew_elliott.