Rishi Sunak will need to find an extra £ 10bn if UK public sector workers are to avoid a painful pay squeeze in the year ahead, as inflation erodes the value of last autumn’s spending settlement for government departments, a leading think-tank warned on Thursday.
Even before the outbreak of war in Ukraine, inflation was set to peak above 7 per cent in April, and to remain around four percentage points higher during the next fiscal year than the Office for Budget Responsibility forecast last October.
Since spending settlements are set in cash terms, this would already be enough to wipe out a quarter of the real-terms increases that were planned, the Institute for Fiscal Studies said in an analysis published ahead of the chancellor’s spring statement, due on March 23.
This means Sunak will have to impose severe real pay cuts on nurses, teachers and other public sector workers whose pay has lagged inflation for the past decade; spend less than he had intended on other public services; or further increase public borrowing, the think-tank said.
Pay reviews for about half of the public sector are decided by ministers, based on recommendations by independent pay review bodies. But the chancellor is likely to give guidance in this month’s fiscal update on how he expects both to respond to the changing economic backdrop.
If the change in inflation outlook was fully factored into public sector pay awards, the cost would total about £ 10bn across the 5.7mn-strong workforce – equivalent to £ 1,750 per worker.
A more likely scenario, the IFS said, was for public sector workers to receive below-inflation pay awards: a 5 per cent award for NHS workers would cost £ 4bn, using more than a quarter of the planned cash increase in the NHS budget for next year, while still representing a real terms pay cut.
Rising energy prices will also put Sunak under more pressure to find extra money for the Ministry of Defense, which spends more than £ 600mn a year on energy and fuel, and was already facing one of the tightest spending settlements.
Carl Emmerson, IFS deputy director, said the department would now be facing real-term cuts, unless the chancellor increased its funding – adding that the UK had clearly reached the end of a long period in which it had been able to fund higher spending on the NHS by cutting defense.
Instead, if the UK wanted to maintain its position as the second largest contributor to NATO, with Germany set to play a bigger role, it would need to significantly increase the defense budget, by up to £ 10bn – implying cuts to other public services or higher taxes.
But the biggest call facing the chancellor will be how far to shield households from the impact of rising energy prices. The IFS said he would need to spend an additional £ 12bn, on top of the £ 9bn already committed, if he wanted to protect people to the same degree he had intended in February.
Paul Johnson, director of the IFS, said that without further government help, people on moderate incomes would be facing “the biggest hit to their living standards since at least the [2008-9] financial crisis ”- and that the chancellor’s response would reveal“ how he sees the limits of government in protecting citizens from buffeting by external forces ”.