Britain's new government is ushering in an age of austerity by making its opening move in what will be a long and difficult struggle to contain its soaring deficit.
Faced with the type of mounting deficits haunting its European neighbours, the coalition led by new Prime Minister David Cameron affirmed Wednesday that it will forge ahead with £6-billion ($9-billion) in public spending cuts this fiscal year. But these promise to be only the first of a series of deep, painful and politically unpopular cutbacks - and eventual tax hikes - as Britain seeks to get its messy fiscal house in order.
The cuts could hamper the fitful recovery of the world's sixth-largest economy from the worst recession since the Second World War, but are regarded as essential if the country wants to avoid the slashed bond ratings, loss of investor confidence and soaring interest costs afflicting some members of the euro zone.
After voters refused to grant any party a majority in the election, markets feared that the first coalition government since the war years might not have the stomach to take the steps needed to bring down a record budget deficit now running at more than £160-billion, or 11.5 per cent of GDP. That's the third-highest level in Europe, after Ireland and Greece. But investors are taking heart from the fact that the hawkish Conservatives will be in charge of fiscal policy, and the centre-left Liberal Democrats have agreed to support both the spending cuts and welfare reform promised by the Conservatives during the campaign.
In his first public comments after being named to the top finance post in cabinet, Chancellor of the Exchequer George Osborne, a 38-year-old Conservative, promised "a significant acceleration in the reduction of the structural budget deficit." He will present what amounts to an emergency budget within 50 days.
Bank of England Governor Mervyn King lauded the proposed budget cuts, calling them "very strong and powerful."
"No government in modern times has ever been left with such a terrible economic inheritance," Prime Minister David Cameron declared.
The Conservatives have set aside a couple of their other financial planks as part of the compromise that brought the Liberal Democrats into the government. These included a plan to boost the threshold for inheritance tax. And they have agreed to boost the tax-free allowance on annual income to £10,000 sought by their coalition partners. An increased tax on banks is also on the table.
"We're in completely new territory," Howard Archer, chief European economist with IHS Global Insight in London, said of the coalition. "You could argue that their initial progress has been impressive. But there's an awful lot of uncertainty and even skepticism about how long they will survive."
The coalition released a joint memorandum on Wednesday covering a range of sticky subjects from deficit reduction and bank reform to European relations. Some will be referred to committees for further study. But the new partners appear to have reached broad agreement on the need for austerity, which was hammered home to all Britons by the Greek debt crisis and the damage it has inflicted on the finances of other deficit-challenged members of the euro zone.
"The government seems to be committed," said Beata Caranci, director of economic forecasting with Toronto-Dominion Bank "Greece provided a nice dose of reality" about what can happen when fiscal policy runs off the rails. "I think the political will is there and I don't think they'll face as much entrenched resistance."
But the government is facing a feeble economy that could get even weaker, as key markets in Europe soften. Unemployment reached a 16-year high in the first quarter and analysts are cutting growth forecasts for next year. Severe public spending cuts could shave estimates of about 2 per cent expansion next year in half, analysts said.
"The cuts are likely to be pretty deep, if not this year, then next year," BMO Nesbitt Burns economist Benjamin Reitzes said. The bank estimates Britain's economy will grow by 2.4 per cent next year, and is waiting to see the impact of the spending cuts before revising that forecast.
During the four-week campaign, all three leading parties skated gingerly around the politically sensitive issue of Britain's worsening fiscal outlook.
"They didn't want to be too specific on things, because obviously the measures are hardly vote-winners," Mr. Archer said.
"The pain's going to be felt, but a couple of factors are in place that put them in a better position [than the deficit-ridden countries of the euro zone]to deal with it," Ms. Caranci said.
These include a jobless rate that remains slightly less than 8 per cent, at a time when Spain's jobless totals, for instance, have climbed above 20 per cent and several other euro zone countries have crept into double digits.
Another important asset is the British pound. Having its own monetary policy enables the Bank of England to focus solely on British conditions, and for the government to quickly gauge market reaction to policy moves.
One new Liberal-Democrat cabinet member could cause some angst in British banking circles. The new Secretary of State for Business, Vince Cable, 67, a former chief economist with oil giant Royal Dutch Shell, had previously called for an overhaul of British banking practices and stronger government efforts to spur lending.