UK government borrowing at record December figure; business activity in sharpest drop for two years

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Chris Williamson, chief business economist at S&P Global Market Intelligence, says:

Weaker than expected PMI numbers in January underscore the risk of the UK slipping into recession. Industrial disputes, staff shortages, export losses, the rising cost of living and higher interest rates all meant the rate of economic decline gathered pace again at the start of the year. Jobs also continued to be lost as firms tightened their belts in the face of these headwinds, though many other firms reported being constrained by an ongoing lack of available labour.

There were some bright spots in the survey, including improved business expectations for the year ahead and a further cooling of inflationary pressures. The overall rate of decline indicated also remains only modest.

But this is undeniably a disappointing start to the year for the UK, reflecting not just short-term hits to growth such as strike action and the rise in energy costs due to the Ukraine war, but also highlighting the ongoing damage to the economy from longer term structural issues such as labour shortages and trade woes linked to Brexit.

Sharpest drop in UK business activity for two years, but growth expectations rebound – PMI

A closely watched survey points to the sharpest decline in UK business activity for two years, while growth expectations rebounded in the wake of reduced inflationary pressures.

The composite purchasing managers’ index (PMI) from S&P Global/CIPS fell to 47.8 in January, a 24-month low. Any reading below 50 indicates contraction; any reading above points to expansion.

This was because of a worsening in the dominant services sector, where activity was also at a two-year low, while manufacturing production decreased considerably in January (index at 46.6), but the rate of contraction was the least marked since July 2022.

The survey says:

January data highlighted a sustained downturn in UK private sector business activity. Although only modest, the overall rate of decline accelerated to its fastest for two years. Service providers experienced a marked loss of momentum since December, with survey respondents citing higher interest rates and low consumer confidence as key factors that held back business activity.

Despite falling output volumes and weak demand, optimism regarding the year ahead outlook for business activity picked up in January and was the strongest since May 2022. This improvement appeared to reflect hopes of a turnaround in global economic conditions and a further slowdown in cost pressures over the course of 2023.

Flash UK PMI Composite Output Index at 47.8 (Dec: 49.0). 24-month low
Flash UK Services PMI Business Activity Index at 48.0 (Dec: 49.9). 24-month low.
Flash UK Manufacturing Output Index at 46.6 (Dec: 44.4). 6-month high.
Flash UK Manufacturing PMI at 46.7 (Dec: 45.3). 4-month high.

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Victoria Scholar, head of investment at interactive investor, has also looked at the weakening dollar.

The US dollar is weakening across the board with the euro, pound, Swiss franc and yen all trading higher against it. The euro is close to a nine-month high. Cable (sterling-dollar) has been on the climb since last September, rallying more than 15% off the lows.

2022 was the year of the King Dollar but the greenback appears to be losing its crown amid a dovish shift from Fed policymakers. Bank of Philadelphia Fed President Patrick Harker recently commented that he is ready for a smaller 25 basis point increase. Expectations are for two 0.25 percentage point increases in the first quarter of 2023 before a pause on interest rates for the rest of the year, in stark contrast to last year’s inflation combative stream of jumbo Fed rate hikes. US inflation appears to have peaked, paving the way for a less aggressive tightening phase.

Focus is on US GDP data on Thursday for clues into the resilience of the US economy in the face of monetary tightening and a challenging macroeconomic backdrop.

Markets summary

European stock markets are mixed. The FTSE 100 index in London is trading 30 points lower at 7,754, a 0.38% drop. Germany’s Dax and Italy’s FTSE MiB have obth edged 0.1% higher, while France’s CAC has gained 0.2%.

The dollar is under pressure against sterling, the euro and the yen, due to different interest rate expectations.

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, explains:

Despite the fiscal squeeze, the pound gained a little more ground against the dollar, trading around $1.24, amid expectations that the Bank of England will still press on with steeper interest rate rises in the months ahead, compared to the US Federal Reserve.

Martin Beck, chief economic advisor to the EY ITEM Club, is more sanguine.

The substantial fall in energy futures prices over the past few weeks is unlikely to make much difference to the government finances over the remaining three months of this fiscal year. However, if sustained, it appears likely to ensure that borrowing is significantly lower than the £140bn that the OBR expects for 2023-2024.

Still, given the support schemes were only due to run for one more year, and the government has adopted a five-year horizon for its fiscal targets, recent developments likely have few implications for March’s budget. Indeed, it’s hard to identify any major developments since the autumn statement that would have a material impact on the OBR’s longer-run forecasts for the public finances, so the EY Item Club is not expecting to see scope for any major changes to policy on 15 March.

Here is our full story on the surge in UK government borrowing:

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Victoria Scholar, head of investment at interactive investor, says:

Public sector borrowing outweighed tax receipts in December, which is typically the case. While tax revenues increased, driven by rises in VAT, PAYE income tax and corporation tax including the energy profits levy, there were decreases in fuel duty, stamp duty and self-assessed income tax.

The central government also spent more on day-to-day expenditure versus December 2021 because of support for households and businesses with rising energy bills, adding to the imbalance. December’s borrowing also spiked largely because of student loan assumptions made by the OBR while government debt interest payable rose because of the effect of retail prices index (RPI) changes on index-linked gilts.

The figures pave the way for a slimmed down budget with few rabbits out of the hat when the chancellor Jeremy Hunt delivers his budget on 15^th March.

Economists are particularly worried about the rise in government debt interest payments, as the cost of servicing central government debt jumped to £17.3bn, more than twice that in the previous month.

Public sector debt totalled £2.5 trillion – around 99.5% of gross domestic product (GDP) at the end of December, reaching one of the highest debt to GDP levels since the early 1960s.

Divya Sridhar, economist at PwC, says:

Falling national debt was one of the five priorities set out by PM Rishi Sunak at the start of the year. The OBR expects net government debt (incl. Bank of England) as a proportion of GDP to rise by 5 percentage points over the next year.

However, slowing inflation, reduced energy bills support and indications that there will be no immediate tax cuts in the spring budget are all likely to bolster public finances in the short term.

Borrowing overshoot limits chances of big budget giveaways

The borrowing overshoot further limits chances of big budget giveaways, says Ruth Gregory, senior UK economist at Capital Economics.

December’s public finances figures provided more evidence that the government’s fiscal position is deteriorating fast. And high government spending in the early months of 2022/23 and the pressures from the weakening economy implies borrowing will come in at about £175bn, broadly in line with the OBR’s forecast of £177bn, but a huge £52bn above the 2021/22 total.

Total tax receipts in December, at £74.6bn, were higher than last December’s £70.6bn. But the recent rises in RPI inflation (to which index-linked gilts are pegged) caused eye-watering high debt interest payments of £17.3bn (OBR forecast: £17.1bn), the highest December figure since records began. Meanwhile, the Chancellor’s energy support added £9.1bn. As a result, total public expenditure came in at £91.2bn, a whopping £16.4bn higher than last December, although that was still a bit lower than the £91.6bn the OBR had expected.

Admittedly, after nine months of the 2022/23 fiscal year, cumulative borrowing is still £2.7bn lower than the OBR’s November forecast (note figures for borrowing in previous months were revised down by a cumulative £4.6bn). Even so, this leaves the budget deficit on a deteriorating path. And that’s before taking into account the government’s energy price support in the remaining three months of the 2022/23 fiscal year.

Overall, today’s worse-than-expected public finances figures will only embolden the chancellor in the budget on 15March to keep a tight grip on the public finances and mean that he waits until closer to the next general election, perhaps in 2024, before announcing any significant tax cuts.

Samuel Tombs, chief UK economist Pantheon Macroeconomics, has crunched the numbers.

Turning to the details of December’s data, interest payments leapt to £17.3bn, from £8.7bn a year ago, due to the big month-to-month jump in the RPI [retail prices index] two months earlier, which primarily reflected October’s increase in consumer energy prices. Note that changes in the RPI determine the accrued level of payouts on index-linked gilts.

In addition, the Energy Bills Support Scheme and the Energy Price Guarantee collectively drove a £4.8bn year-over-year rise in subsidies.

Meanwhile, national insurance receipts rose only 2.2% year-over-year, compared to the 16.0% growth rate recorded in the first seven months of the fiscal year, primarily as a result of the reversal of April’s hike towards the beginning of November. Total receipts, however, came in £0.3bn higher than the OBR forecast.

To help them cope with spiralling energy prices, the government is giving households £400 towards the cost of their energy bills, paid in six evenly spread portions between October and March. Businesses have also received support with their energy bills, but this will be scaled back drastically from April.

Introduction: UK government borrowing at record December high due to energy support and debt interest

Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.

The UK’s public finances have worsened considerably. The government borrowed £27.4bn in December, the highest December figure on record, largely because of spending on energy support schemes and higher debt interest.

December’s borrowing was £16.7bn higher than in December 2021, and the highest since monthly records began in January 1993. Economists had forecast £17.75bn.

The figure was also £9.8bn more than the £17.6bn forecast by the Office for Budget Responsibility (OBR). This means that the chancellor may have little room for tax cuts in the spring budget.

Debt interest payable by the central government amounted to £17.3bn, also the highest December figure on record. This is largely because of the impact of the rise in inflation, as measured by the retail prices index, on index-linked UK government bonds, known as gilts.

Public sector net borrowing excluding public sector banks was £27.4 billion in December 2022.

This was the highest December borrowing on record, largely because of spending on energy support schemes and higher debt interest.

➡️ https://t.co/wFBmlu7vSV pic.twitter.com/uGnySTO3DF

— Office for National Statistics (ONS) (@ONS) January 24, 2023

The chancellor of the exchequer, Jeremy Hunt, says:

Right now we are helping millions of families with the cost of living, but we must also ensure that our level of debt is fair for future generations.

We have already taken some tough decisions to get debt falling, and it is vital that we stick to this plan so we can halve inflation this year and get growth going again – creating better paid jobs across the country.

Elsewhere, the US carmaker Ford has announced 3,200 job losses in Europe, with Germany hard hit. The news sent its share price 3.2% higher.

US markets had a good start to the week, with the S&P 500 closing above the 4,000 level, up 1.2%, and the Nasdaq 100 leading the way higher with its second daily gain of more than 2%. There were also more job cuts in the tech sector, as the music streaming service Spotify said it was cutting about 600 jobs – the latest big tech company to admit it expanded too quickly during the coronavirus pandemic.

Michael Hewson, chief market analyst at CMC Markets UK, says:

The outperformance in tech appears to point to a growing conviction on the part of investors that the Fed will soon have to look at cutting rates before the end of the year, although to look at bond markets yesterday, yields also moved higher, as money flowed out of treasury markets.

With a lot of tech companies starting to announce job cuts, as well as other measures to rein in costs, and inflationary pressures showing further signs of easing, it would appear that US investors are starting to think in terms of the next move higher, despite concerns over lower profits.

Given the uncertain economic backdrop this comes across as a bit of a leap of faith, and its also notable that while US markets have started to gain momentum in the past few days, European markets have started to lose some of their early year momentum.

While US markets surged higher yesterday it is notable that today’s European market open is likely to be a much more tepid affair, suggesting perhaps that investors in Europe don’t share the same enthusiasm about the economic outlook, despite the reopening of the Chinese economy, which may help to provide a demand boost.

Today’s flash PMI surveys for January are expected to show a further improvement in economic activity due to the sharp falls in wholesale energy prices from the peaks in August and September.

The Agenda