Deficits have remained excessive long after these crises have passed, leaving many economies lumbering with a form of ‘fiscal long-covid’ – where upward pressure on interest rates is stifling investment and growth. 

The symptoms vary by region. The US faces fiscal debts of approximately 6% of GDP. The UK faces an unprecedented combination of elevated public sector debt levels, excessive deficits (largely financing current spending and not investment) and poor economic growth. The euro area, too, is struggling to grow – but for different reasons; despite its comparatively modest fiscal deficits, large current account surpluses and creaking infrastructure hold the region back. 

What, then, does all this mean for growth in the years ahead?

The Federal budget deficit in the US reached $1.8trn (6.4% of GDP) in the fiscal year 2024 versus $1.7trn (6.2% of GDP) in 2023, despite no fiscal emergencies. Borrowing at such levels, despite a resilient economy, is troubling. In the near-term, the deficit will likely remain at current levels, as weaker tax receipts and continued spending prevent any meaningful improvement. 

Donald Trump’s proposals show no appetite for reducing future budget deficits. His election win does not alter our forecast for the immediate fiscal year 2025, when we forecast a $1.9trn budget deficit (6.4% of GDP).

Longer term, we expect Trump to modify and extend the Tax Cuts & Jobs Act of 2017, as well as propose tax cuts for corporations, increase military spending, and expand immigration enforcement and deportations. He also proposes ending the taxation on tip income, overtime pay and Social Security benefits. To offset some of the associated costs, Trump plans to rely on imposing new tariffs on imports and repealing energy and environmental-related spending. 

However, borrowing needs will remain exceptionally high, and any cyclical improvement in the budget does not erase the long-term challenges presented by an ageing population in the decades to come.

Having endured a fiscal/financial market crisis (the Truss government’s ‘mini Budget’ of autumn 2022), markets may have expected a more orthodox, cautious approach from a new UK government with a sizeable majority. 

In fact, the 2024 Autumn Budget appeared to test market tolerance via higher-than-expected multi-year deficit projections that were not, as billed, primarily for investment. Two-thirds of the public spending increases were for current, not investment, spending. Against this, the independent Office for Budgetary Responsibility left its productivity and GDP growth projections essentially unaltered. 

The large overshoots in projected deficits should not obscure the fact that the Autumn Budget brought the largest tax rises since 1993. These tax rises – centered on an employer payroll tax, National Insurance, and extended to capital gains, inheritance and duties – are likely to thwart growth, not spur it.

Rising debt-servicing costs are also starting to bite. The UK government’s interest payments have doubled over the past year, and in the 2024-25 financial year, we project the interest bill on the government debt to stand at roughly £120bn. This is a far cry from the ‘magic money tree’ interlude of zero interest rates and quantitative easing. 

The question is how long it will take before the additional borrowing and spending have a positive effect on growth, and whether the debt repayment is, ultimately, worth it.  

Overall, the euro area appears in a more stable situation than in the past: the public sector debt ratio has almost returned to its pre-covid levels (88% vs 84% in late 2019) and is appreciably lower than in the US or the UK. New European Central Bank tools should allow governments to manage fiscal positions with some tranquility.

The euro area’s cyclically-adjusted fiscal balance is seen improving in 2024-25 but remains significantly worse than pre-pandemic, from close to zero in 2019 to around -3% in 2024, and down from -3.7% in 2023. 

Some weaknesses do remain nationally. France, in some political turmoil, is a case in point. Italy, and possibly Belgium and Finland, could be at risk in the event of a large shock requiring significant deficit-financing. Still, the current macro fundamentals, the ECB’s Transmission Protection Instrument and some measure of political stability in Italy (once at the centre of euro area concerns) offer some reassurance. 

In many respects, the bigger challenge in the euro area – which encompasses fiscal policy – is ‘under investment’. Germany seems to need a fiscal boost to deal with economic weakness. As articulated in the ‘Draghi Report’, the EU as a whole needs to invest substantially in the coming years to close its productivity gap. Ideally, much of this investment would be led by the private sector, but some higher public spending (or public-private partnerships) might be necessary. 

Economic growth across key global regions (% GDP)

Visit natwest.com/yearahead for more expert insight to help you navigate the year ahead and speak with your NatWest contact about how you can prepare today.