Inflation to return to its two percent target in 2027

It comes as part of the government forecaster’s Economic and fiscal outlook, published in conjunction with chancellor Jeremy Hunt’s Autumn Statement. It said that, while it will hit 11%, the peak would have been 2½ percentage points higher without the introduction of the energy price guarantee (EPG). 

The EPG has seen the typical household’s annualised energy bill capped at £2,500 – which will be in place until April 2023 – rising to £3,000 next winter.  

Rising prices to erode real wages
Additionally, the OBR has said the rising prices that the UK will experience will erode real wages and reduce living standards by seven percent in total over the two financial years up to 2023-24, wiping out the past eight years’ worth of growth. This comes despite the more than £100bn worth of government support.  

The squeezes being made on real incomes, as well as a rise in interest rates and a fall in house prices, all weigh on consumption and investment – tipping the economy into a recession lasting more than a year from the third quarter of 2022, with a peak-to-trough fall in GDP of two percent.  

Unemployment is also set to rise by 505,000 from 3.5% to a peak of 4.9% in the third quarter of 2024.  

Inflation

Inflation is estimated to drop “sharply” over the course of 2023 and will go below zero in the middle of the decade, driven by falling energy and food prices. It will then return to its two percent target in 2027.  

As a result, the UK will see a recovery in real incomes, consumption and investment with GDP returning to growth in 2024, with output recovering to its pre-pandemic level in the fourth quarter of that year. GDP will then grow more rapidly, reaching 1¾% in 2027.  

Impact of government policy

Since the OBR’s last forecast, which took place in March this year, fiscal policy has been through a period of uncertainty – first increasing and then reducing the medium-term deficit. Of the major fiscal policies outlined, near-term support for households and businesses with their energy bills has been announced – costing £86.4bn in total across the 2022-23 and 2023-24 financial years.  

Additionally, there has been a medium-term fiscal loosening, driven by personal and corporate tax cuts costing £48.2n in 2027-28 – of which all but £21.1bn was cancelled. The Autumn statement also saw a set of medium-term fiscal tightenings being announced, raising £19.3bn in 2024-25 and material sums thereafter, rising to £61.7bn in 2027-28.  

Relative to the OBR’s March forecast, the net effect of these measures will increase borrowing by £64.2bn in 2022-23 and £39.8bn in 2023-24 – reducing the fall in output when the economy is in recession and unemployment is rising.  

Policy decisions will then reduce borrowing from 2024-25 onwards when the economy is recovering and unemployment falling by amounts rising to £39.4bn in 2027-28. Taking both these policy decisions and the forecasts, the deficit rises from £133.3bn last year to £177bn this year.  

Borrowing then falls by £37bn next year to £140bn and continues falling to £69.2bn in 2027-28. The tax burden, meanwhile, rises from 33.1% of GDP in 2019-20 to 37.1% at the next forecast horizon – making it the highest sustained level since the Second World War.  

Alongside this, total public spending is set to rise – going from 39.3% of GDP in 2019-20 to 43.4% of GDP in 2027-28.  

Underlying debt

This increase in borrowing is forecast to push underlying debt up sharply, going from 84.3% of GDP last year to a 63-year high of 97.6% in 2025-26. However, a mixture of tax rises, spending cuts and a pick up in GDP growth will see this fall modestly in 2026-27 and 2027-28. 

Due to this increase, the government’s two legislated fiscal targets to balance the current budget and get underlying debt falling in 2025-26 are on course to be missed by £8.7bn and £11.4bn respectively.  

Driven by the scale of the energy shock and the recession it has induced, the government has announced new targets – namely to get borrowing below three percent of GDP and getting underlying debt falling in five years’ time. This is achieved, respectively, with £18.6bn and £9.2bn to spare.   

However, the near tripling of interest rates since March means the share of revenues consumed by servicing that debt rises from under five percent in 2019-20 to 8½% in 2027-28, leaving the public finances more vulnerable to future shocks or swings in market sentiment.