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UK Budget Surplus Lower than Expected in July as Multiple Threats to Public Finances Loom on Horizon

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UK government borrowing fell less than was expected by the market during July, leading overall borrowing for the current financial year to rise by a touch and drawing a line under the previous financial year, which had seen the government's need for cash fall to its lowest level in nearly two decades.

Borrowing declined by more than £7 bn in July, according to the Office for National Statistics, leaving the government with a funding surplus of £2 bn after it tapped the market for £5.7 bn in June. However, this was less than the £3.7 bn cash pile the consensus was looking for.

That surplus is down from around £2.5 bn in July 2018, which was the largest since the same month in the new millennium year of 2000. The smaller than expected decline in borrowing means the government has now tapped the market for £16 bn in the current financial year, which is £6bn more than in the same period one year ago. 

"Today's public finance data provide a further indication that the long period of falling budget deficits in the UK since 2009/10 is likely go into reverse in 2019/20," says John Hawksworth, chief economist at PWC. "Supporting the economy through potential Brexit-related turbulence is likely to be the top priority in the spending review and Budget this autumn, even if this implies some further widening of the budget deficit next year."

The national debt pile stood at £1.8 trillion in July when debts associated with public sector banks are excluded from the totals, which is equal to around 82.4% of GDP. Such excluded debts would include borrowing associated with the rescue of Lloyds Banking Group and RBS during the financial crisis.

The debt-to-GDP ratio falls to 74.1%, with the debt pile at £1.62 trillion when bonds acquired by the Bank of England (BoE) through quantitative easing are excluded from the total. The BoE has bought £435 bn of government and, more recently, corporate bonds in the years since the financial crisis as part of an effort to lift inflation by stimulating the economy with lower bond yields. 

Wednesday's figures could mean the UK will struggle to best the fiscal performance seen in the financial year to the end of March 2019, which saw borrowing of only £23.6 bn. That 2018 number was down more than £18 bn on the prior year and the lowest public sector net cash requirement for 17 years. 

But with the October 31 Brexit date fast approaching and political decision makers on both sides still no closer to agreeing a deal that facilitates anything other than a 'no deal' Brexit, risks to the public finances are high. 

"The small surplus in July’s public finances wasn’t enough to make up for the jump in borrowing since the start of the financial year and means that government borrowing still looks like it will overshoot the OBRs forecast," says Thomas Pugh at Capital Economics.

Government could easily be forced to borrow more if an EU exit hurts corporate profits, which taxes are levied upon, because tax revenues would fall. It might also face being lumbered with a higher welfare bill if an exit leads to a rise in unemployment, which has fallen to its lowest level since the early 1970s since the referendum of 2016. 

However, Brexit is just one of the factors that could drive government borrowing higher during the months ahead, because new international accounting rules that came into force among private sector companies some time ago are due to impact the classification of some student loans later this year. 

International Financial Reporting Standard 9 (IFRS 9) began entering into effect in January 2018, which saw companies move from a system where they only recorded 'recognised losses' on loans and investments in their financial statements, to one where they now have to also report 'expected losses'. 

"A change in the accounting treatment of student loans in September will raise the deficit by more than £10bn a year. However, we doubt this will prevent the Chancellor from loosening fiscal policy in a one-year spending review in September or in an autumn budget, either before or after Brexit," says Pugh. 

For government, which is typically called upon to pay for a certain proportion of all student loans due to non-payment and government guarantees, this means it will now have to record an equivalent portion of student loan issuance as both spending and debt of its own. 

Capital Economics Pugh says this could add around £10 bn to the deficit this year while the ONS estimates it will raise the deficit by £12 bn from September. 

Pugh also says that exactly how far government borrowing rises in the months ahead, will depend largely on the outcome of the Brexit process. This could be because the government is widely expected by economists to lift spending in order to support growth if the UK leaves the EU without having agreed a formal exit by October 31. 

 

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