New fiscal year faces early challenges as borrowing rises – EY ITEM Club comments

• The public finances faced early challenges at the start of the new fiscal year, with borrowing coming in much higher than a year ago. This raises the risk that borrowing over the full fiscal year could be higher than the Office for Budget Responsibility's (OBR) latest forecast due to higher inflation and interest rates.
• However, the factors that could cause borrowing to overshoot this year should prove temporary and so will be of little relevance to fiscal policy choices. The OBR's view of medium-term growth prospects remains central to the amount of headroom available to the Government. And there's a decent chance of a fiscal policy reset after the next general election, regardless of which party wins.

Martin Beck, chief economic advisor to the EY ITEM Club, says: “Public sector net borrowing (excluding public sector banks) came in at £25.6bn in April, £11.9bn higher than a year ago and £3.1bn above the OBR's forecast. Continuing the pattern seen at the end of the last fiscal year, growth in tax revenues underwhelmed, with receipts excluding transfers to the Bank of England’s Asset Purchase Facility rising at their slowest pace in just over two years. Meanwhile spending was boosted by a combination of the cost of energy support schemes and high inflation adding to debt interest payments.

“It's very early days to judge whether the OBR's 2023-2024 full year borrowing forecast of £131.6bn will prove too low. On the one hand, the likelihood that GDP and inflation will come in higher than the OBR anticipates means that tax receipts should outperform. But a spending overshoot is also likely, reflecting not only the impact of higher inflation but also the effects of higher short-term and long-term interest rates on debt interest payments. However, the factors which could drive a bigger deficit are likely to prove temporary and shouldn’t affect policy choices given that the fiscal rules are judged on a rolling five-year timeframe. More important, as far as the OBR's forecasts are concerned, will be whether it sticks to its bullish (relative to the Bank of England) medium-term growth projections.

“Political choices will also be key. A package of pre-election fiscal announcements seems likely. But the shape of policy post-election is far less certain. Current plans imply very tight spending allocations from 2025-2026, which might be difficult to implement. And were the Opposition to win the election, a change of fiscal rules can’t be ruled out.”