24 July 2024
There will undoubtedly be some interesting times ahead for the new Chancellor of the Exchequer, Rachel Reeves, as she inherits the "worst economic circumstances since the Second World War". Amid speculation that inheritance tax changes are just around the corner, raising more than £1 billion a year, it's important to appreciate the state of the UK economy and finances.
It is no secret that taxation, at 38% of national output, is at its highest level since the 1940s. During the election campaign, both Labour and the Conservatives confirmed they would not increase income tax or VAT (except a Labour move to introduce VAT on private school fees), although the Institute for Fiscal Studies talked of a "conspiracy of silence" on funding for UK public services.
In many ways, the Labour Party is stuck between a rock and a hard place. It promises to be hard on public finances yet is already in receipt of third-party advice about a 5.5% salary increase for teachers and NHS staff. This is approximately twice the level expected by the Treasury and could open up the new government to claims of "old Labour," dominated by the unions.
The reality is that the Labour Party today is very different, taking a more central approach to capture the votes of the general public. However, a 5.5% salary increase for teachers and NHS staff could lead to similar claims for other areas of the public sector. The proposed pay rises have prompted warnings they could fuel an $8 billion fiscal deficit ahead of the Labour Party’s first budget in the autumn.
There is some debate as to how the UK economy will perform in 2024 and 2025. For example, KPMG believes that GDP growth will hit 0.5% in 2024 and rise to 0.9% in 2025. Over the same period, they believe that inflation will remain static at 2.6%, slightly up from the current rate of 2%, which is also the Bank of England's target.
Interestingly, over the last few days, we have seen the International Monetary Fund increase its UK economic forecast for 2024 to growth of 0.7% and reiterate its earlier forecast of GDP growth of 1.5% during 2025.
Looking at interest rates, there is a consensus that rates are likely to approach 3.5% towards the end of 2025, even if the initial downward movement has been constantly delayed. Recent economic data has been mixed with many experts suggesting that high interest rates are starting to bite. Is the first interest rate reduction since March 2020 on the way?
We know the Labour government is keen to increase housebuilding in the UK, with a target of 1.5 million new homes. However, many of the larger housebuilders have expressed frustration at relatively high mortgage rates and the challenges of building and maintaining their land banks. There is no doubt Labour’s plans will increase competition within the mortgage sector, but with the cost of living crisis still very real for many families, it would be helpful to see mortgage rates fall in the short to medium term.
The Labour government has been very vocal and highly critical of the state of public finances left by the previous government. Some experts are concerned that this downplaying of the economy and public finances may serve a political purpose but could spook markets and investors.
Yes, the national debt is higher than when the Conservatives took power in 2010, but we have had the tail end of the financial crisis and the pandemic. The annual deficit is actually lower, as is unemployment and inflation since the previous government took office in 2010. Political parties all use smoke and mirrors, but is this tactic really helpful?
Incoming governments tend to have a honeymoon period, especially after such a long time out of office, and so far, the Labour government hasn't really put a foot wrong. The public sector pay negotiations will be the first real challenge, but there have been a number of welcome policy announcements targeting growth for the UK economy. Is this the rebirth of new Labour?
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