U.K., Canada Lead West in Weaning Economies Off Covid-19 Pandemic Support

U.K., Canada Lead West in Weaning Economies Off Covid-19 Pandemic Support

London’s new tax and spending policies, along with faster growth, are forecast to shrink the U.K.’s budget deficit in coming years

The U.K. dialed back government stimulus for the fast growing British economy, one of the first big Western economies to step away from the emergency policies put in place to tackle the coronavirus pandemic as concerns over inflation intensify.

Treasury chief Rishi Sunak set new tax and spending policies that together with faster growth are forecast to shrink the U.K.’s budget deficit significantly over the next few years, putting the U.K. in the vanguard of countries reducing fiscal support for their economies as the strong but fitful recovery from the pandemic continues.

Behind the U.K.’s shift is a buoyant growth outlook and concern over surging inflation. That has fueled expectations the Bank of England may soon nudge up interest rates to tame price increases, well ahead of the U.S. Federal Reserve and other major central banks.

Annual inflation in the U.K. is expected to accelerate to around 5% next year, more than double the BOE’s 2% goal, according to forecasts produced Wednesday by the Office for Budget Responsibility, which assesses U.K. fiscal policy.

The policy moves in London highlight the delicate transition governments are facing as they balance a rapid rebound from the pandemic against proliferating risks that could shove recovery off course.

Supply-chain disruptions are hurting businesses and fueling faster inflation around the world, squeezing household incomes. Many workers idled by the pandemic have yet to find new jobs. Vaccination means Covid-19 is in retreat in many parts of the world but not defeated.

In the U.K., cases are well above those detected in its European neighbors, raising the possibility the government will need to reimpose growth-sapping public-health restrictions to stave off a winter crisis.

“There’s a question of how far do you try to start down the path of fiscal rectitude, and how far do you say, ‘We’re still coming out of Covid, let’s nurture the recovery,’ ” said Stuart Adam, a senior research economist at the Institute for Fiscal Studies, a think tank in London. “There’s an obvious trade-off, and there are risks in both directions.”

Mr. Sunak billed his budget as a chance to rebuild the U.K. economy after the pandemic and the country’s split with the European Union. He announced big new spending in areas including health and education and an increase to the minimum wage for those age 23 and over, as well as tax breaks to boost research and development.

Much of the extra spending is expected to be financed by higher tax revenue from faster growth. The Office for Budget Responsibility, the U.K. fiscal watchdog, said it expects the British economy to grow 6.5% in 2021 and 6% next year. The International Monetary Fund expects the U.S. to record growth of 6% in 2021.

But Mr. Sunak also set new tax-raising measures, on top of an increase to the main corporate tax rate announced in March. New measures included a levy on employees, employers and the self-employed to finance extra spending on health and social care.

“Today’s budget does not draw a line under Covid. We have challenging months ahead,” Mr. Sunak said in an address to Parliament. “But today’s budget does begin the work of preparing for a new economy post-Covid.”

The overall result is the budget deficit is forecast to narrow from 7.9% of annual gross domestic product in the fiscal year through March to 3.3% the following fiscal year, according to the OBR.

Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics, said such a decline would be the biggest year-over-year squeeze on borrowing since World War II.

By the 12 months through March 2025, the deficit is forecast to have shrunk to just 1.7% of GDP, the OBR says.

The move to rein in borrowing comes after the U.K. already paused major pandemic-related support measures. The government in September closed its flagship job-support program that at its peak was paying the lion’s share of the wages of almost nine million Britons, roughly a third of the workforce. The OBR said it estimates the government spent £315 billion ($433 billion) on pandemic support since March last year.

The U.K. isn’t alone in rethinking its fiscal stance. In Canada, the government last week brought an end to its broad, pandemic-fueled emergency-income benefits for households and businesses. The programs—at a cost since March 2020 of nearly 300 billion Canadian dollars, equivalent to $242 billion—led to a big rise in borrowing but helped stabilize the economy through the public-health crisis, economists say. The Bank of Canada said Wednesday it would also end its quantitative-easing program Nov. 1.

The U.S. and the 19-nation eurozone remain more firmly in stimulus mode, by contrast, in the hope of driving faster growth and putting more people back to work.

At the world’s major central banks, the debate over how soon to tighten policy to tame inflation is heating up, as booming consumer demand and supply-chain snarl-ups cause anxiety among officials over whether rapid price-growth will prove fleeting or lasting.

The Bank of England is due to weigh whether to raise its benchmark interest rate from a record low of 0.1% as soon as next week, though most economists expect a move in December or at its first meeting of 2022 in February is more likely. The BOE is already scheduled to complete a pandemic-related bond-buying program at the end of the year.

The rising cost of living is straining household budgets in Britain, especially among those on low incomes. Doreen Thompson, who is 70 and from south London, said her monthly pension of about £1,000 is scarcely enough to cover rent, council tax, food and energy bills, which have more than doubled to almost £250 in recent months. The former social worker can no longer afford to keep the heating on all day and has cut back on nonessential toiletries. She scours supermarket clearance shelves for bargains and has switched to cheaper brands to further trim her spending.

“I’m on the edge,” she said.

By Jason Douglas and Isabel Coles

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