Fitch Warning Gives Osborne Tailwind

Fitch warned earlier today that the UK government faces a "formidable" challenge in addressing it's debt and deficits. Although sterling sold in reaction, Fitch's warnings may help the new UK government. It provides additional justification for a significant cuts in spending and a tighter fiscal policy in general.

Before parliament today Chancellor of the Exchequer Osborne emphasized the structural nature of the of the UK's deficit, which means that it cannot grow out of it. Some estimates suggest that nearly half of the UK's deficit is structural in nature--ie what it would be at full employment.

I presented a similar assessment of the US in last week's "Gas Now, Brake Later" posting that the IMF estimates that assuming no action the US structural deficit will be near 6% of GDP in 2015 compared withe 4% in the euro zone).

Osborne, however, differs from the assessment offered by the US Administration, by suggesting that the level of the deficit threatens the recovery. The Obama Administration argues to the contrary that cutting the deficit before the growth cycle becomes entrenched risks a double dip, which would prove even more costly in fiscal terms.

Osborne has hinted at sharp cuts in spending and hints of a VAT hike. More info is likely prior to the June 22 budget unveiling.

Lastly, note that Osborne specifically rejected the EC call that budgets are presented to it prior to the submitting them to parliament. Osborne assured the UK MPs they would see the budget before Brussels.