Hammond Hemmed in as Brexit, Pay, Housing Loom Over U.K. Budget

(Bloomberg) -- So many demands, so little money.

U.K. Chancellor of the Exchequer Philip Hammond is under intense pressure from his own party to steady the Conservative ship in his annual Budget on Wednesday.

From an end to pay restraint for public-sector workers to more cash for housing, the wishlist is growing as the Tories battle to end the state of crisis that has gripped the party since the botched general election in June.

Trouble is, Hammond has limited room to loosen austerity, and almost certainly much less than he thought he had eight months ago.

The outlook for growth has worsened and the chancellor already has to find money to pay for decisions made since the last Budget in March. These include an extra 1 billion pounds ($1.3 billion) for Northern Ireland -- the price Prime Minister Theresa May paid for a deal to prop up her minority government -- and a 2 billion-pound U-turn over increasing taxes on self-employed workers. 

Hanging over everything is, of course, Brexit. The cabinet is divided and investors are preparing for the possibility that Britain leaves the European Union in 2019 without a deal, a scenario that could throw Hammond’s fiscal plans into disarray.

Here are seven charts that show the challenges facing the chancellor and areas where any budget giveaways might be targeted.

Productivity Blues

The budget will unfold against a backdrop of continuing dismal productivity. The Office for Budget Responsibility has given up waiting for things to improve -- output per hour is barely higher than it was before the financial crisis -- and has signaled a significant downgrade to its outlook. It suggests the economy is set to be smaller than previously estimated. That’s bad news for wages and tax revenue. Tackling the productivity puzzle is a long-term challenge that Hammond is expected to address in his budget statement.

More Borrowing

Thirty-four billion pounds and possibly more. That’s how much the OBR is expected to add to its deficit prediction for the five fiscal years through March 2022, according to the average of independent forecasts this month. It would leave borrowing through March 2021 more than 120 billion pounds higher than projected before the vote to leave the European Union. The good news is that healthy tax receipts should see the shortfall this year come in below previous estimates, meaning future years will be better than they would be otherwise.

Fiscal Rules

The Labour Party has won support by promising an end to austerity but Hammond is in no mood to unleash a spending spree. Britain had its credit rating cut by Moody’s in September, and the chancellor fears that abandoning the fiscal rules he set himself only a year ago would do further damage in the eyes of investors. He is required to reduce structural borrowing to less than 2 percent of economic output in 2020-21 with the aim of eliminating the deficit altogether by the mid-2020s. In March, this gave him 26 billion pounds of headroom to help the economy navigate Brexit. The loss of productivity potential and some fiscal giveaways could see his buffer slashed next week. But only a “very poor” economic scenario would wipe it out entirely, according to the non-partisan Institute for Fiscal Studies.

Pay Pressures

Millions of public-sector workers are now in their seventh year of pay restraint. Pay was frozen for all but the lowest earners in 2010 and increases have been capped at 1 percent since 2013 as part of efforts to reduce spending. Inflation meanwhile is running at 3 percent, meaning the real value of earnings is falling. The pressure on the government is building, with unions threatening strike action and hospitals complaining of a recruitment crisis as Brexit deters EU nurses. Hammond has eased the cap for some workers and spoken of the need for more flexibility on pay. But lifting wages across the board would be expensive. The government bill amounted to about 180 billion pounds last year.

Housing Crisis

The election disaster taught the Conservatives that young people are fuming about the cost of housing. The answer, say critics, is to build more homes. Britain has put up about 150,000 new dwellings a year on average since 2011, half the number experts say is needed to meet the demands of a growing population. May this week declared it her personal mission to “build more homes, more quickly.” Steps have been taken in recent weeks to boost the supply of social housing, including the promise of cash, but a plea from Communities Secretary Sajid Javid to borrow tens of billions of pounds to launch a major building program appeared to gain little traction.

The NHS

The state-funded National Health Service has been spared the cuts inflicted on some departments, but it is struggling to cope with the demands of an ageing population. The number of people waiting for treatment could hit 5 million by 2021 unless Hammond allocates more funds, the head of NHS England, Simon Stevens, warned this month. In an intervention in the Brexit debate, he demanded that the health service receive the money promised to it during the Brexit campaign. Vote Leave controversially claimed that Britain could divert 350 million pounds a week to the NHS as a result of no longer paying into the EU budget. 

Welfare Cuts

There is pressure on Hammond to ease the squeeze on welfare. A planned freeze to most working-age benefits will leave millions of low-income households worse off and increase child poverty, according to the IFS. Further changes to welfare seem unlikely given the controversy over the government’s flagship welfare program. Universal Credit, which combines six benefit payments into one, is being rolled out across the country but critics say the time some people have to wait for their first payment is causing increased hardship.

To contact the reporter on this story: Andrew Atkinson in London at a.atkinson@bloomberg.net.

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Eddie Buckle, Flavia Krause-Jackson

©2017 Bloomberg L.P.