UK borrowing is due to hit a peacetime record of £394bn this year as the government grapples with the cost of the coronavirus pandemic, with chancellor Rishi Sunak admitting that “the economic emergency has only just begun”.
Mr Sunak said the UK was facing a fall in gross domestic product of 11.3 per cent in 2020, the largest fall in output for 300 years, as he set out his one-year spending review for 2021/22.
The government has spent about £280bn since March on its response to Covid-19. Scars from the crisis would continue to be felt until the middle of the decade, Mr Sunak said, with the economy likely to be 3 per cent smaller in 2025 than predicted in March.
The Office for Budget Responsibility, which produces independent forecasts alongside Mr Sunak’s statement, said current projections assumed an “orderly transition” to a trade deal between the UK and the EU.
It warned that if the UK came out of the transition period on December 31 without a new deal with Brussels, GDP would take a 2 per cent hit.
The OBR is forecasting a surge in unemployment to 7.5 per cent in the second quarter of next year when Covid-19 job support measures are withdrawn, equivalent to 2.6m people out of work. This will compare with 3.8 per unemployment before the start of the pandemic and a current rate of 4.8 per cent.
Mr Sunak vowed to invest in schools and hospitals and to continue supporting business through the pandemic — with some of that spending funded through a multibillion-pound cut to foreign aid.
But he warned that pay rises in much of the public sector would be “paused” next year. However, there would be a pay increase for 2m state workers on below-average pay and for more than 1m NHS workers.
Meanwhile, the living wage would be increased by 2 per cent in line with the recommendation of the Low Pay Commission, he said.
Anneliese Dodds, Labour’s shadow chancellor, said the cut in state wages for firefighters, police officers and teachers would damage the economy. “This takes a sledgehammer to consumer confidence,” she said. “[Workers’] spending power is going down, so they will spend less in our small businesses and on our high streets.”
Mr Sunak said that departmental spending would have risen an average 3.8 per cent in real terms over the two years between 2019 and 2021, the fastest rate in 15 years.
The rises this year will include an increase of £6.6bn for the core health budget, £2.3bn for capital spending in the NHS and an increase in the schools budget of £2.2bn. “The British people’s priorities are this government’s priorities,” Mr Sunak said.
Baroness Liz Sugg quit as a junior Foreign Office minister in protest at the deep cut to the foreign aid budget. Former Tory international development aid secretary Andrew Mitchell said the cut was likely to lead to 100,000 preventable deaths “mainly amongst children” and urged Tory MPs to vote against the policy.
Mr Sunak said that it was difficult to justify spending 0.7 per cent of national income on aid during a domestic fiscal emergency “when we need to prioritise our limited resources”. He has cut the level of overseas aid support from 0.7 per cent to 0.5 per cent of national income, equivalent to about £4bn next year.
The chancellor said he had listened with “great respect” to those arguing to keep the target “but at a time of unprecedented crisis, the government must take tough choices”.
Aid spending would increase once again once the fiscal situation had stabilised, he said.
Justin Welby, the Archbishop of Canterbury, wrote on Twitter that the aid cut was “shameful and wrong” and “contrary to numerous government promises and its manifesto”.
While Mr Sunak spoke about large increases in spending, the spending review documents from the OBR showed that the chancellor is expecting to cut both day-to-day and capital spending for the final years of this parliament, compared with his projection in March before the pandemic.
By the time of the next scheduled election in 2024-25, the chancellor is planning to cut £12.9bn from every day public spending plans and a further £3.3bn from capital spending budgets.
Mr Sunak also announced a new Levelling Up Fund worth £4bn from which councils will be able to bid for grants. He also confirmed that the Treasury would launch a new National Infrastructure Fund, which will in part replace the UK’s membership of the European Investment Bank once the Brexit transition period comes to an end.