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With a new prime minister and new chancellor, the UK looks set for a new fiscal policy too. Tax-cut and spending promises suggest a significantly looser stance designed to boost the economy as it leaves the European Union.

New leader Boris Johnson’s pledges are already looking expensive. They include spending on schools, hospitals and the police, plus income-tax changes, that total at least GBP33 billion – 1.5 per cent of GDP – and that's before adding in a number of uncosted policies.

Realistically, the tax cuts might be phased in gradually, but slower global and UK growth could also reduce revenues and therefore raise borrowing forecasts – perhaps by around GBP20 billion to GBP30 billion or 1 per cent to 1.5 per cent of GDP. We would expect this to be front-loaded to achieve the desired effects of insulating the UK economy against the effects of a ‘no deal’ Brexit.

An early budget prior to the scheduled 31 October EU exit might thus see the Office for Budget Responsibility revise current-year borrowing from the previously expected GBP29 billion to nearer GBP40 billion – whether or not there is a deal with Brussels − and from GBP21 billion to GBP41 billion for 2020/21.

Though the government has said it plans to finance some of this spending from the GBP27 billion of so-called fiscal headroom − the possible extra borrowing that would not breach existing fiscal targets − new chancellor Sajid Javid might prefer to outline new rules, perhaps promising to keep the current budget in surplus as long as economically feasible. That could allow borrowing for investment, but also for everyday spending in harder times.

However, we think an early budget is unlikely to boost the economy significantly before 31 October. It might raise confidence for some but a ‘no deal’ exit could cause GDP to fall by around 1.5 per cent, shrinking from the final quarter of 2019 until mid-2020. And the Office for Budget Responsibility estimates it could reduce government revenues by GBP30 billion by 2021/22.

An immediate fiscal package of around 1 per cent of GDP next year, as well as a monetary response from the Bank of England, should mean a 'no deal' recession is relatively mild. But if the disruption is severe, the government might also cut VAT if demand slumps − pushing the deficit out further.

There is some scope for this fiscal expansion: the UK’s public finances have been one area of economic success in recent years, with the deficit falling to 1.1 per cent of GDP. Even the public debt burden has started to fall. And with 10-year bond yields at 0.5 per cent, borrowing looks affordable.

Indeed, even with extra borrowing and issuance, we would not necessarily see higher bond yields. Not only will it be difficult for UK interest rates to detach from moves in other developed markets, but in a ‘no deal’ Brexit scenario, we would expect the UK bank rate to be cut to 0.1 per cent and quantitative easing resumed with a further GBP65 billion of asset purchases taking the total to GBP500 billion.

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