Beyond the budget

With Budget day near, is the speculation overhyped? At CIL’s Economic Update, David Smith shares his hopes and fears for the UK economy.

With so little time until the Budget, speculation is at fever pitch. But David Smith, veteran Economics Editor at the Sunday Times, suggests that the hype may be overdone. Speaking at CIL’s 18th Annual Economic Update, he revealed his hopes and fears for the UK economy, under the new Labour government.

If, as Harold Wilson once said, a week is a long time in politics, then a year is an eternity. And certainly, there have been major changes since CIL’s last Economic Summit in the autumn of 2023. Back then, the UK was grappling with persistently high inflation and interest rates. Look back to late 2022 and conditions were even worse, prompting predictions that house prices could slump by 20% and inflation could easily hit 18%.

Today, the economic environment is considerably more benign. Interest rates are heading down, inflation is under control and we have a new government under Sir Keir Starmer, who is determined to make the UK the fastest growing economy in the G7.

Despite a rocky start to Starmer’s premiership, respondents to CIL’s eighth Investment 360 Index are upbeat. Short-term optimism has shot up from 19% to 48%, the highest in many years, while around 60% of respondents are hopeful that conditions will improve over the next five to 10 years. And, even though only 18% think Labour is doing a good job, with another 48% suggesting results so far have been mixed, this is the most upbeat assessment of government behaviour since our survey began.

And yet, as Smith points out, many challenges remain. Our economy may be back in growth mode but the pace is anaemic. Between the end of 2019 – just before the pandemic – and now, the UK has managed cumulative GDP growth of just 2.9%. That compares to 3.8% in France, 4.7% in Italy and a remarkable 9.4% in the US. On a GDP per head basis, the figures are even worse. According to Smith, growth in real GDP per head has risen 5.5% since the Global Financial Crisis, compared to almost 46% in the previous 16 years.

Mind the gap

Little wonder then, that Starmer and his Chancellor Rachel Reeves have put growth firmly at the centre of their agenda. The need to deliver a sea-change in output is particularly stark because, as the Government has made only too plain, it has a problem – namely a £22bn black hole in the public finances, which has to be addressed to retain market confidence.

Against this backdrop, Smith posed four questions:

• How bad was the government’s economic inheritance?
• How fast and far will interest rates fall?
• Will Labour build 1.5m new homes and deliver stellar economic growth?
• What will be in the 30 October budget?

The Government’s economic inheritance is better than it could have been, with two quarters of growth in the first half of this year and more expected for the remainder of 2024 and through 2025. Smith is hopeful too that inflation will remain below 2.5%, allowing a steady reduction in interest rates to around 3 to 3.5%.

Good as far as it goes. But the OECD still expects UK GDP of little more than 1% this year and next and, as Starmer and Reeves know only too well, that is not really good enough.

That puts the Government in a tight spot. There is a huge fiscal deficit, public sector debt is now 100% of GDP, the tax burden is higher than it has been since the 1940s and it is heading towards unprecedented levels of around 37%. Corporation tax has risen to 25% and the long freeze on income tax and National Insurance allowances and thresholds has created the biggest stealth tax in history.

That freeze is due to last until 2028 and there is no sign that Labour will remove it. But Reeves has pledged not to actively increase these taxes and she has to find a way to plug the fiscal black hole.

No clear winners

Smith points out that the Resolution Foundation is closer to Labour than any other think tank so their recent musings might give us the strongest clues about what might be in Labour’s first Budget in more than 14 years.

Resolution’s stated aim is to improve living standards for those on low-to-middle incomes and the group suggests this could be achieved by raising Capital Gains Tax (CGT), introducing exit charges for anyone leaving the country, fiddling with Inheritance Tax and levying National Insurance on employers’ pension contributions.

Reeves has said that those with ‘the broadest shoulders’ will face the biggest burden under Labour and, superficially at least, Resolution’s proposals target business and the better-off. But, as Smith points out, each of the think tank’s ideas is problematic. Most ‘wrinkles’ in CGT exist for a reason, he says, and there is a danger in making changes that are perceived as anti-business and politically motivated rather than genuine solutions to the fiscal problem. Forcing companies to pay National Insurance on contributions to employee pension schemes would just encourage businesses to cut those contributions. And making alterations to pension tax relief could disincentivise people from contributing to their pensions in the first place.

In short, Smith believes that Labour was foolish to rule out changes to income tax, National Insurance, corporation tax and VAT as that promise has left precious little room for manoeuvre. On the other hand, it means that any tax changes introduced in the Budget are likely to be quite niche. While they may be frustrating or worse for some people, they are unlikely to have a major effect on business or the consumer. So, even though confidence has been weakening in the run-up to this Budget. Smith suggests it may not be as dramatic as many fear.

He also suggests that Reeves may change the way that government debt is measured to give her more room to increase borrowing. And he questions whether the government might expand the definition of new homes to include splitting properties into flats or converting offices and shops into residential space, so called ‘net housing additions’. This could help the Government move closer to its target of 1.5m new homes over the life of the Parliament but it would still be highly ambitious.

What really matters

Ultimately, Smith believes that growth is the biggest challenge. How can the UK move to the top of the G7 economic league when it currently lags behind every country in that group bar Germany?

Among respondents to our survey, political stability was cited as the single most important way in which the new government could boost M&A activity. Smith agrees that political stability would be welcome after years of turmoil. But he is clear that stability is not an elixir for growth. And he points out that the outcome of the US election is a major unknown, with neither Kamala Harris nor Donald Trump touting helpful, pro-growth policies.

Respondents also called for closer alignment with the EU. Smith suggests that, whatever Starmer’s private thoughts on the matter, he will not want to be seen as pushing for closer relations with Europe. He would prefer to be seen as responding to public and/or business opinion instead – moving closer to Brussels because consumers and companies are calling for it.

More positively, the Government has pledged to raise public investment, work with the private sector and create a more innovative and enabling state. Smith also highlights the resilience of the UK economy, which has consistently fared better than expected in recent years, despite shocks from Brexit to the pandemic to Russia’s invasion of Ukraine.

Finally, Smith takes heart from his anecdotal ‘skip index’. No skips on his street suggest little or no economic growth. Four or more skips point to unsustainable growth. Two is just right – and that is the situation today.