Watchdog warns Brexit risks heightening financial shocks

Britain's fiscal watchdog said the public finances are "much more sensitive" to higher inflation and interest rates as it warned that Brexit risks heightening financial shocks.

The Office for Budget Responsibility (OBR) said it was almost inevitable the UK would face a recession or a financial crisis over the next 50 years and the Government risked putting the UK finances on an "unsustainable path" if it failed to shore up the deficit during brighter economic times.

Prime Minister Theresa May has vowed to deliver a balanced budget by the middle of the next decade, but is facing increasing pressure to end austerity and increase Government spending.

In its Fiscal Risks report, the watchdog said: "The budget is still in deficit by 2 to 3% of GDP - as it was on the eve of the crisis - and net debt is more than double its pre-crisis share of GDP and not yet falling.

"As a result, the public finances are much more sensitive to interest rate and inflation surprises than they were."

It added that the fallout of the UK's future trading arrangements with the European Union posed a greater risk to the public finances than the size of a Brexit divorce bill.

While the watchdog would not be drawn into predicting how a potential trade deal with the 27-nation bloc might impact upon the deficit, it said Brexit could exacerbate other risks and fiscal shocks the Government may face.

The OBR said: "The new Government must also manage the risks posed by Brexit. These do not supplant the possible shocks and likely pressures that we have already discussed, but they could affect the likelihood and impact of many of them.

"A lot of attention focuses on the possible 'divorce bill', but, while some numbers mooted for it are very large, a one-off hit of this sort would not pose a big threat to fiscal sustainability.

"More important are the implications of whatever agreements are reached with the EU and other trading partners for the long-term growth of the UK economy, which we do not attempt to predict here.

"If GDP and receipts grew just 0.1 percentage points more slowly than projected over the next 50 years, but spending growth was unchanged, the debt-to-GDP would end up around 50 percentage points higher."

The fiscal referee said the outcome of the General Election increased the risk to the public finances by boosting the likelihood of higher spending.

The OBR flagged the £1 billion cost of the Conservative Government's confidence and supply agreement with Northern Ireland's Democratic Unionist Party and "austerity fatigue" as potentially creating a "risk of upward revisions to current spending limits".

Responding to the report, Chancellor Philip Hammond said the analysis was a "sober reminder" of the challenge the country faces and underscored why the Government must deliver on its "commitment to deal with our country's debts".

He said: "The Labour Party would ignore these warnings, adding to the bill that our younger generation will have to pay.

"Under Jeremy Corbyn's catastrophic plans, the independent Institute of Fiscal Studies (IFS) estimate the national debt would be over £100 billion higher by the end of this Parliament than under a Conservative Government - or £6,000 per working household."

John McDonnell, Labour's shadow chancellor, said: "The Tories want to blame Brexit for their failures on the economy, but what this report really reveals is that one of the biggest risks to our economy is Theresa May's weak Government, and the last seven year of Tory economic failure."