Britain is on 'thin ice,' warns ex-Bank of England chief economist — and it must act to 'appease financial markets'

The U.K. is "on thin ice" ahead of its critical Autumn Budget, according to a former chief economist of the Bank of England, who warned the government must curb public spending and refrain from painful tax hikes.

Speaking to CNBC's Steve Sedgwick, Andy Haldane — a member of the central bank's Monetary Policy Committee until 2021 — said there were "perils" running into the budget update, currently scheduled for Oct. 28.

"The truth is we are skating on pretty thin ice in fiscal terms, and nothing would be worse both economically and politically than if the ice were to crack beneath our feet," Haldane said on the sidelines of the How Britain Can Win conference, hosted by Goldman Sachs 10,000 Small Businesses UK.

Asked if the metaphorical ice is going to crack, he responded that there is "a risk of that" happening. The "single most effective way" to head off such an event, he added, would be for the government to "appease financial markets" by showing it is "able and willing to take the knife to public spending."

"That is the Achilles' heel of this government," Haldane told CNBC. "Unless and until action is taken on that, [Prime Minister Andy Burnham] will remain, alas, in hock to the bond market."

Burnham, who replaced Keir Starmer as prime minister over the summer, has previously criticized the U.K.'s fiscal policy as being "in hock" to bond traders.

His emergence as the frontrunner to oust Starmer rattled bond markets earlier this year, with investors perceiving Burnham as much more left-leaning than his predecessor.

With yields on U.K. government bonds, known as gilts, surging amid domestic and global instability in recent years, Britain now has the highest government borrowing costs in the G7.

While Haldane noted that international bond markets had created a "hostile environment for all government borrowers," he said the U.K. was particularly impacted because the country is "a leveraged bet on the world economy."

"Our inflation is higher and stickier. Our growth is lower and stickier. We have yet to balance the books this century — so history is not on our side. The facts are not on our side. That's why the ice is thin."

Haldane said Burnham's push to end the U.K.'s so-called triple lock mechanism — where the state pension rises at the same rate as the highest of inflation, average earnings growth, or 2.5% — was a "good first instalment." But he added that welfare remains a "totemic issue" for the governing Labour party and the bond market.

Gilt markets came under pressure last year when Starmer's finance minister Rachel Reeves watered down her initial plans to cut welfare spending last year, following a revolt from backbench MPs.

The looming Autumn Budget will be the first unveiled by Burnham's administration, with finance minister John Healey telling the Financial Times last month he wanted to carve out a fiscal "buffer against uncertainty."

Healey is tasked with bringing public spending and borrowing under control, with sticky inflation, elevated borrowing costs and lackluster economic growth adding to the urgency of balancing the books.

But Burnham and Healey have also said easing living costs, devolving political power to local authorities and raising defense spending remain priorities. While the government has identified some savings to help fund its defense plans, Burnham and Healey have yet to spell out the full mix of further savings or tax measures needed to pay for the additional expenditure while sticking to the U.K.'s so-called fiscal rules.

Burnham has refused to rule out tax hikes, and the British press is reporting that windfall taxes targeting banks might be on the table.

Lenders operating in the U.K. have lobbied against that proposal, with JP Morgan boss Jamie Dimon meeting with Burnham and Healey in London last month.

In his interview with CNBC, Haldane warned against homing in on businesses in the budget.

"I think most would say that the great engine of growth is the private sector," he said. "[But] there's a real sense within the private sector that they are taxed out. A sense we're borrowing too much rather than too little, and therefore more of the same was not the route to growth, and I hope that's a penny that's beginning to drop inside government."

However, Haldane added that he thought the current government is "significantly underweight in its economic and financial expertise."