In a breakfast discussion for Eton Bridge Partners on November 24, held at the Café Royal, London, I addressed four questions:
- Is the recovery from the pandemic still in good shape, or is it already showing signs of fading?
- How worried should we be about Covid-19 this winter, following the upsurge in infections and the introduction of new restrictions in some European countries?
- Inflation is increasing sharply, as are business costs. How long will this last and how will the Bank of England respond?
- This has been a big year for announcements of higher taxes. Will the increases announced be enough to stabilise the public finances, or will more be required?
On the first question, the upturn in the economy this year has been very pronounced, but this has brought stresses and strains in its wake. There are widespread shortages of materials and other supplies, as well as of some labour. Labour shortages were not envisaged by the chancellor when he announced the furlough scheme in March 2020. The fear was that the pandemic would be followed by high unemployment.
The stresses and strains are real, and they have led to some erosion of business and consumer confidence. Retail sales, rather than booming after the re-opening of non-essential retail in April, have disappointed. But we should remember that these are the problems of a growing economy and of switching many economies back on again after lockdowns. British businesses are confident enough to have lifted the number of people on payrolls above pre-pandemic levels and there are 1.3 million vacancies in the economy. The economy should achieve its fastest growth in the post-war period this year, admittedly after a slump in 2020, and the omens are good for 2022.
Secondly, what about Covid? Until recently the big issue about the pandemic appeared to be low vaccination levels in poorer countries. But a sharp rise in infections in many European economies, and the politically unpopular reimposition of lockdowns and restrictions has put the focus firmly back on the coronavirus closer to home.
The UK is running roughly 40,000 new cases a day, as has been the case for some time. But, thanks to the vaccination programme, including a successful rollout of booster jabs, this is not translating into significantly higher numbers of hospitalisations and deaths. In Europe, while new restrictions will take the edge of economic growth, they are unlikely to bring it to a halt. One lesson of the past 18 months is that economies have become better tat growing through restrictions.
Third, the rise in inflation is real and visible. Consumer price inflation is already 4.2% and retail price inflation 6%. Industry’s output price inflation is running at 8% and official figures for average earnings growth – pay – while distorted by the furlough scheme, are high.
The big question is whether much of this rise in inflation is temporary, or transitory, reflecting comparisons with low prices a year earlier and the impact of shortages. Second-hand car prices, unusually, have risen by 27% since April, as people have switched to used vehicles because of shortages of new ones. Energy prices have moved to a new higher level, but it would be surprising if the increases seen recently, and in prospect for next April, were to persist.
Though some of the inflation is likely to be temporary, the onus is still on the Bank of England to raise official interest rates from the current all-time low of 0.1%. It is likely to do this, raising Bank Rate to 0.75% or 1% over the next few months. It could go further, if inflation turns out to be more persistent, and in an economy that has become accustomed to very low rates that would be a challenge. The Bank’s hope is that rates do not move out of their post-financial crisis range.
Finally, what about tax? Rishi Sunak has had his eyes on raising taxes for some time. Last year, as well as raising corporation tax, he was drawn to taxing capital gains tax (CGT) as income and restricting higher rate pension tax relief. In the event, only corporation tax survived in his blueprint, though the increase, from 19% to 25%, to take effect in April 2023, is a big one. The idea of increasing CGT attracted a significant backlash from entrepreneurs, while pension taxation has been the subject of big changes in recent years.
Sunak has also announced two other big tax rises, however. From April, incomes tax allowances and thresholds will be frozen, which at a time of high inflation will amount to a noticeable tax increase. April will also see a 1.25 percentage point increase in both employer and employee National Insurance contributions. Taken together with the corporation tax increase, these hikes will add up to a £40 billion annual increase and take the tax burden to its highest since Clement Attlee was prime minister in the early 1950s.
Will they be enough? Circumstances can change but the Office for Budget Responsibility and Institute for Fiscal Studies think that enough has been announced to achieve falling government debt as a percentage of gross domestic product by the end of the parliament. Let us hope so anyway.
As always, a huge thank you to David for attending and hosting our breakfast event. We appreciate you taking the time to share your insights and answering our questions on the UK economy and international relations.
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