UK budget watchdog warns of long-term Brexit risk for public finances

By David Milliken

LONDON (Reuters) - Britain will need to curb public spending further or raise taxes if leaving the European Union does long-term damage to economic growth, underscoring the importance of the country striking new trade deals, the government's budget watchdog said on Thursday.

The Office for Budget Responsibility said ensuring robust trade agreements was more significant for the long-run health of Britain's public finances than the size of any "divorce bill" to settle one-off liabilities with the EU.

"While some numbers mooted for it are very large, a one-off hit of this sort would not pose a big threat to fiscal sustainability. More important are the implications of whatever agreements are reached with the EU ... for the long-term growth of the UK economy," the OBR said.

Just a 0.1 percentage-point fall in the annual growth rate of the economy and tax revenues would cause Britain's debt-to-GDP ratio to be 50 percentage points higher after 50 years, if public spending plans remained unchanged, the public body added.

A continuation of Britain's recent weak productivity would also make tax rises or spending cuts more likely, the OBR said.

Finance minister Philip Hammond said the report was "a stark reminder of why we must deliver on our commitment to deal with our country's debts".

British public debt stands at 1.6 trillion pounds ($2.1 trillion) or 80 percent of GDP, more than twice its level before the financial crisis, though below some other major economies such as the United States, Japan and France.

DEBT RISK

The budget deficit fell to a 10-year low of 2.4 percent of GDP last year - leaving debt as a share of GDP on track to fall by a small amount each year.

Hammond wants to run a balanced budget by the middle of the next decade so that the debt burden will fall faster, but Prime Minister Theresa May's minority government is under pressure to loosen the purse-strings after years of austerity.

The OBR said that debt tended only to fall slowly as a share of GDP, but typically rose sharply during times of war or economic crisis.

Britain's higher debt level than before the financial crisis meant it was more vulnerable to rises in interest rates or inflation than in the past, the OBR said.

Other big risks to the public finances in the medium term included rising healthcare and pension costs as the population ages, and, to a lesser extent, lower immigration.

Under a scenario of a sharp recession combined with much higher interest rates that is similar to one which the Bank of England tested British banks against last year, British public sector debt could rise to 114 percent of GDP, the OBR said.

The OBR did not quantify the risk of a major war, climate change or a cyber-attack.

($1 = 0.7741 pounds)

(Editing by William Schomberg and Andrew Heavens)