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Rishi Sunak feels the heat as economic effect of Ukraine war hits UK

Rishi Sunak is facing mounting Conservative pressure to cut taxes to help households cope with a worsening cost of living crisis as the economic fallout of the war in Ukraine starts to hit Britain.

The chancellor is also facing Tory calls to increase defence spending, adding to the political problems he faces as he tries to maintain a tight fiscal grip in his spring economic statement on March 23.

Cabinet ministers believe Sunak will have to yield to pressure, some of it expected to come from Prime Minister Boris Johnson, to offer new help to households amid Treasury fears that inflation could rise above 7 per cent in May.

“The boss loves spending money,” said one minister, predicting that Johnson will demand short-term help for families facing higher fuel and food prices as Russian sanctions hit energy supply.

But Sunak is determined to downgrade expectations; one ally said the March 23 event was “a statement, not a Budget or a spending review”.

Chancellors’ statements traditionally contain many fewer new tax or spending measures than a full Budget, although autumn statements delivered by George Osborne became mini-Budgets in all but name.

Column chart of Cumulative improvement in central government current receipts over Office for Budget Responsibility October forecast (£bn) showing Revenues are stronger than expected

The chancellor is braced for a very difficult few weeks as Tory MPs press the case for tax cuts or higher spending. But Sunak wants to bring borrowing under control so he can cut taxes nearer to the general election.

“We have to get the NHS back on its feet,” said one of his allies. “The MPs wanting to cut taxes don’t have to deal with the trade-offs we have to deal with in the Treasury.”

Sunak’s argument is that the situation is “too volatile” to make big fiscal judgments now, given the uncertain fallout of western sanctions against Russia.

The new energy price cap, which rises in April to £1,971 from £1,277, will offer some protection to households until the next cap is set in October; at that point some have predicted it could rise above £3,000.

Sunak is also wary about injecting more money “artificially” into the economy, for example by scrapping a planned £12bn rise in national insurance contributions (NICs), fearing it could push inflation even higher.

Calls for the reversal of the NICs increase, intended to fund NHS treatment and social care, have been led in the cabinet by Jacob Rees-Mogg, the Brexit opportunities minister, and are echoed by many on the Tory right. Labour is also opposing the rise.

David Davis, a former cabinet minister, said last weekend: “The case for dropping this rise is even stronger after recent events.” Sunak is determined to resist such pressure and has so far been backed by Johnson.

Meanwhile, Robert Halfon, a Tory MP who has led the campaign to freeze fuel duty in recent years, is prominent among those calling for a cut in value added tax or fuel duty as oil prices surge and petrol rises above £1.50 a litre.

Halfon told the Financial Times that Treasury ministers keep warning that “if we do that we won’t have tax cuts later on”. But he said: “If pump prices go to £1.60, it won’t just be motorists but businesses and the NHS that are affected.”

Sunak’s problems have been reinforced by calls for him to fund another big increase in defence spending, even though in 2020 he increased the military budget by £24bn over the following four years.

Tobias Ellwood, Tory chair of the House of Commons defence select committee, said: “We’ve entered an era of instability that requires us to urgently review the impact of growing threats and how our defence posture must advance.”

Ellwood said the defence budget should increase to “a minimum of 3 per cent of gross domestic product if Britain wants not only to defend its interests but play an enhanced leadership role on the international stage in these uncertain times”.

Johnson said on Monday that Britain was one of the biggest Nato defence spenders — the UK plans to spend 2.4 per cent of its GDP on the sector — but he suggested the west would have to do more.

David Gauke, a former Treasury minister and fiscal Conservative, said Britain was entering “extraordinary times” — just as it did when Covid hit in 2020 — and Sunak should offer short-term help to struggling households.

“I think there’s a case for greater intervention to protect people from the cost of living crisis in the short term without offering too many hostages to fortune to the long-term fiscal position,” he said.

Pressure on Sunak, who last month announced a package to help with rising energy bills, to do more to alleviate the cost of living crisis will be amplified by better than expected public finances so far in the 2021-22 financial year.

After 11 months of data, the government has had to spend £8.8bn more than expected on servicing the national debt as a result of higher borrowing costs and much higher inflation pushing up the value of almost £500bn of inflation-linked government bonds.

But while higher inflation has increased spending, it has also boosted income from taxes far exceeding the forecasts from the October Budget made by the Office for Budget Responsibility, the independent fiscal watchdog.

After strong self-assessment receipts in January, even with HM Revenue & Customs relaxing the usual end-of-the-month deadline, the fiscal watchdog noted that government receipts were £29.1bn higher than expected.

The overall deficit for 2021-22 looks likely to be around £20bn lower than the Budget estimate, economists say, which gives the chancellor room for manoeuvre in his spring statement, since some of the revenue overshoot will continue into the coming financial year.

Line chart of Cumulative public sector borrowing (£bn) showing The government's fiscal deficit is lower than expected in 2021-22

The Treasury worries that the good news this year on the deficit will prove fleeting because higher debt interest costs will limit the improvement relative to forecasts in future years.

Most economists think there is enough wriggle room in the public finances for Sunak to make a gesture to limit the squeeze on incomes, but the deficit cannot be ignored because it is still large and pressures on public spending remain very strong.

Isabel Stockton, a research economist at the Institute for Fiscal Studies think-tank, said Sunak had scope for “one-off support” to help households cope with higher energy bills. But she added: “If the chancellor decides to delay tax rises this spring, he will need to find ways to commit credibly to other ways of dealing with these public spending pressures.” 

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