Long-term fiscal sustainability is governed by what happens to a combination of economic growth, government borrowing costs and the primary budget balance. Since we’re sceptical that the tax cuts announced by Kwasi Kwarteng last week will boost long-term economic growth, fiscal policy will need to be tightened in future in order to put the public finances on a more stable path. The size of the necessary fiscal adjustment will be governed by what happens to interest rates. If government borrowing costs hover around 3.5-4.0%, then a fiscal squeeze of around 1.0-1.5% of GDP might be required to stabilise the public debt to GDP ratio. But if fiscal concerns drive borrowing costs higher, a larger squeeze may ultimately be needed.
Note: We’ll be discussing the outlook for sterling and gilt yields – along with other big FX and bond market stories – in a 20-minute online briefing on Tuesday, 27th September at 10:00 ET/15:00 BST (Register here).
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