UK economy’s make-or-break budget

June 22, 2010

BRITAIN-BUDGET/

- Mark Bolsom is the Head of the UK Trading desk at Travelex Global Business Payments. The opinions expressed are his own-

Later today, Chancellor George Osborne will unveil his first budget, where he is widely expected to take a tough stance. To the financial markets, this emergency budget is the agenda-setting piece of this parliament. Markets, media, consumers and businesses alike have all braced themselves for what has been billed as the sharpest fiscal tightening since the end of the Second World War.

This budget will make-or-break the UK economic recovery. In order to secure the UK’s treasured credit rating, it is essential Osborne details how he will cut the deficit. In Labour’s final budget, Darling refused to elaborate on how he planned to halve the deficit in four years, which damaged the UK’s credibility. If Osborne fails to obtain the essential buy-in from the financial markets, the UK’s credit rating will fall and sterling will plunge against most major currencies.

Therefore Osborne’s primary challenge is to balance the market’s thirst for deficit cuts without derailing economic recovery – and he will have a tough job. Credit agencies have already warned that cuts must be far-reaching – most recently Fitch said the UK needs to cut its borrowing by an additional 1% of GDP per year, if the UK wants to maintain its triple AAA credit rating.

With January’s VAT rise back to 17.5%, another rate rise this budget seems likely. If it is raised to 20%, as rumoured, it would raise £12 billion, which could contribute to raising the income tax threshold (a Liberal Democrat pre-election promise).

However, 2010′s VAT rise has already been blamed as a main contributor to rising inflation, helping to push it up and above the Bank of England’s 2% target. If Osborne does raise VAT, it is very likely this will cause inflation to rise, putting more pressure on the Bank of England to raise interest rates. This is another balancing act Osborne will have to handle very carefully.

So far, the political rhetoric has centred around tougher austerity measures, and, with the stakes so high, we all expect that from the budget today. But if Osborne is seen to go too far, it will spark fears of a return to recession and drive the pound lower in trading today.

What do you think George Osborne’s budget will hold?

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Picture credit: Chancellor George Osborne, holds 19th-century finance minister William Ewart Gladstone’s old Budget box for the cameras outside 11 Downing Street, before delivering his first Budget to the House of Commons in London June 22, 2010. Osborne will announce on Tuesday swingeing spending cuts and tax rises in what will be the tightest budget in a generation and the first big test for the coalition government. REUTERS/Andrew Winning

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