UK to extend furlough scheme until September as government vows to use ‘fiscal firepower’

LONDON — British Finance Minister Rishi Sunak will on Wednesday announce the extension of the country’s furlough scheme until the end of September and is expected to say the government will deploy its full “fiscal firepower” to support the economy.

The budget comes as nationwide Covid-19 restrictions are set to be gradually unwound over the coming months, culminating in full removal on June 21. Meanwhile, more than 20 million people in the U.K. have now received a first vaccine dose.

In his Budget speech on Wednesday, Sunak is expected to outline the government’s “three-point plan” to navigate the U.K.’s economic recovery, in terms of current fiscal measures and plans to restore the country’s ravaged public finances in the future. He will also plot out the next stage of the government’s Plan for Jobs, launched in October.

The Coronavirus Jobs Retention Scheme will continue subsidizing 80% of the wages of furloughed employees until the end of September, but businesses will be asked to contribute 10% in July and 20% in August as the economy reopens.

“There’s now light at the end of the tunnel with a roadmap for reopening, so it’s only right that we continue to help business and individuals through the challenging months ahead – and beyond,” Sunak is expected to say.

The government has embarked upon unprecedented public spending as the economy posted its sharpest contraction in more than 300 years in 2020. At Sunak’s last fiscal announcement in November, he unveiled the country’s largest peacetime budget on record.

Alongside the extension to the furlough scheme, Sunak is expected to deliver further welfare safety measures, business grants, loans and mortgage holidays, as well as grants for the self-employed and updates to back-to-work schemes. He will also extend the GBP20-per-week boost to Universal Credit, the British social security payment, until September.

“We’re using the full measure of our fiscal firepower to protect the jobs and livelihoods of the British people,” Sunak is expected to tell the House of Commons.

Morgan Stanley analysts are anticipating a GBP20 billion package of measures, including the furlough extension and a targeted support program for pandemic-sensitive sectors.

Future tax hikes?

The U.K. has taken on a direct fiscal cost of GBP285 billion ($397 billion) since the onset of the pandemic, or 13.7% of GDP, according to the Office for Budget Responsibility (OBR), which has cautioned of a lasting hit to public finances.

As a result, some analysts cautiously expect the Chancellor to look to raise some cash in Wednesday’s budget.

Morgan Stanley Head of European Economics Jacob Nell and U.K. Economist Bruna Skarica said Sunak could announce tax hikes, touting a potential corporation tax increase to 21% from the fall, along with the introduction of an online sales tax and further action on green taxes.

“The UK’s fiscal stance remains more hawkish than its U.S. and euro area counterparts, with Chancellor Sunak stressing the need to put the public finances back on a sustainable footing after the pandemic,” Nell and Skarica said in a note Friday.

“While we expect him to sound hawkish next week, and deliver some tax hikes – perhaps GBP5 billion – as down-payment on his intent, we see him announcing fiscal tightening – perhaps 2% of GDP in tax hikes – only in the autumn, to come into force from April 2022.”

In all, Morgan Stanley predicts that this fiscal year’s GBP5 billion of additional tax receipts will rise to GBP10 billion next year.

“Further fiscal tightening we think – of 2% of GDP – will be announced in the autumn, once the UK has clearly recovered from COVID-19,” they said in a note Friday.

However, UBS Economist Dean Turner suggested that following a better-than-feared fourth quarter for the U.K. economy, the government’s fiscal position may not be as fragile as last reported by the OBR. As a result, UBS does not expect any immediate tax hikes, but suggested future changes to corporation tax were likely to be signaled along with other modest tweaks, such as pensions and freezing of income tax thresholds.

Must not ‘pull the rug out’

The U.K.’s better-than-expected fourth quarter means the government’s forecasts may be upgraded, according to Capital Economics Senior U.K. Economist Ruth Gregory, but she cautioned that a premature unwinding of fiscal support could be detrimental to the recovery.

The OBR currently projects that the economy will be 3% smaller than its pre-pandemic trajectory by 2026, with a budget deficit of about GBP100 billion (3.9% of GDP) in 2025/26.

Gregory determined that if Sunak wants the budget deficit to return to pre-pandemic levels by 2026, he might have to tighten fiscal policy by around GBP45 billion per year.

“Add in a desire by the government to raise taxes sooner rather than later so that tax rises don’t happen just before the 2024 general election, then it’s entirely possible that the Chancellor takes the first steps to claw back some revenue in this Budget,” she said.

However, she suggested that the immediate priority will be preventing long-term economic scarring, and Sunak will for now be content to signal intent to tighten at future fiscal announcements.

Capital Economics expects Sunak to announce a loosening in fiscal policy relative to current plans amounting to about GBP25 billion (1.2% of GDP) in 2021/22.

“But the risk is that over the next two years he will be tempted to pull the rug out from under the feet of households and businesses by reducing the budget deficit at a faster pace than is currently scheduled,” Gregory said.

“Not only would that undermine the economic recovery, but it could also cause more problems for the public finances than it solves.”