How the economic stars are aligning to reduce Rishi Sunak’s budget black hole

The Government is on course to save up to £15bn per year on its forecast debt interest payments, as the rebound in financial markets boosts the Chancellor’s financial position.

Jeremy Hunt's decision to move the date of the next fiscal statement from October 31 to November 17 gives the Office for Budget Responsibility (OBR) more time to include lower borrowing costs in its forecasts as financial markets have recovered, helping fill the fiscal hole facing the new administration before he even starts on a full plan to raise taxes or cut spending.

“Had our forecast been published on 31 October, it would have been based on market determinants, including for gas prices and gilt yields, from the early to middle part of October,” an OBR spokesman says.

“Postponing the date to November 17 means that we will take a later window for these market prices.”

Martin Beck, chief economic advisor to the EY Item Club, says conditions in financial markets are “all looking more positive”.

It means there is less pressure to tighten the public purse strings, which is critical as the nation faces recession which risks being made worse by higher taxes.

“Markets have calmed, so if he goes further than what they have already done on the U-turns, he should take the blame rather than blaming his predecessor,” says Beck.

“Up to now he could blame market turbulence and Truss, but now things have settled down.”

So what are those improvements in markets, and how significant are they?

Gilt yields

The Government borrows money by issuing bonds, known as gilts, which are bought by investors, such as pension funds.

It usually pays a low interest rate on these, but borrowing costs have been rising all year and went into overdrive in the wake of September’s heavy-borrowing mini-Budget.

Yields on benchmark 10-year bonds spiked from below 3pc at the start of September to just over 4.5pc on 27th, amid a crisis in parts of the pensions market.

But a rescue by the Bank of England, Kwarteng’s exit and a series of U-turns by Hunt restored calm and brought that cost down below 3.7pc.

The Government’s total debt is closing in on £2.5 trillion, every little helps when it comes to keeping down interest payments.

Falling gilt yields are likely to knock at least £6bn off the fiscal black hole.

Bank of England interest rates

When markets were in meltdown, expectations grew that the Bank of England would have to raise interest rates far more sharply to restore order.

Traders briefly thought the base rate would have to rise above 6pc – incurring significant pain for the Government, not least because it has to pay banks the base rate on reserves held at the Bank of England, and a jump from 0.1pc a year ago to 6pc in 2023 represents an enormous shock to spending.

But now, markets expect a peak at a more reasonable, if still high, 5pc.

This is particularly important ahead of the Autumn Statement as the OBR bases its predictions of the base rate, and so Government interest payments, on market expectations.

James Smith, economist at the Resolution Foundation, predicts the combined drop back in gilt yields and base rate predictions – as long as these are sustained moves – means the OBR can cut between £10bn and £15bn from its estimates of annual debt interest spending by the Government.

Inflation

Price rises are a scourge for the public finances, with interest payments on around one-quarter of the national debt linked to inflation.

But there are tentative signs the peak could be in sight, with pressures on costs potentially turning around.

The pound has rallied, recovering the losses suffered in the wake of the mini-Budget.

Sterling is back above $1.15, its gains initially driven by a return to stability in British markets, then by a slide in the dollar as traders reined in expectations of rate rises in the US.

A stronger pound helps hold down the price of imported goods, and so inflation.

Lower energy prices should also help.

Energy bills

Gas prices have tumbled in international markets in recent weeks, crashing from €220 per megawatt hour when Liz Truss announced her support scheme on September 8 to €100 now.

This is a vital lift to the public finances. The subsidy, which caps unit costs so a household using the average amount of energy will pay £2,500 per year in bills, was far and away the most expensive policy announced in her short premiership, with the first six months expected to cost £60bn.

Analysts at ING estimate that at this level, the bill would only come in at £50bn if the cap was kept for two years, as initially planned by Truss, let alone the six months currently guaranteed. That is down from previous estimates as high as £140bn.

That reduces a giant cost for the Government, and if prices keep falling, it should ultimately bring bills down below the current artificial cap of £2,500 – relieving some of the pressure on family finances which is a key cause of this winter’s likely recession.

Mortgages

It is not only the Government which benefits as a big borrower. Homeowners are paying more for their mortgages than they were at the start of the year, but interest rates have come off the highs seen in when markets were at their most tumultuous.

The average rate on a two-year fixed-rate mortgage dropped from 6.65pc to 6.55pc within a day of Ms Truss's resignation, according to financial data provider Moneyfacts.

Meanwhile the average rate on a five-year fixed-rate fell from 6.51pc to 6.43pc.

This was followed by a further rate drop when Rishi Sunak was declared winner of the Conservative leadership contest.

The average rate on a two-year fix is now 6.5pc, down from 6.54 yesterday, while the average rate on a five-year fix fell from 6.41pc to 6.36pc.

Taking the full extent of falls into account, this would reduce payments by £288 a year for a typical £250,000 loan.

Until Truss’s departure, the average rate on both two-year and five-year fixes had been steadily climbing in the aftermath of her chaotic mini-Budget.

On the day the former prime minister announced her resignation, the average rate on a two-year fix stood at a fourteen-year-high.

Some lenders have already reduced rates by over half a percentage point.

This will support buyers and reduce the scale of the crunch in the market. It is good news for the Government’s finances too.

A crashing housing market bodes ill for revenues from stamp duty – which raked in £17.7bn in the past 12 months – as well as the wider economy which benefits from people moving house.