17 June 2024

Neither of the main parties manifestos contained any big surprises. The big difference between the two is that the Conservatives manifesto has focused on large tax cuts, which would only be funded in part by reductions in spending on some forms of welfare. Labour, meanwhile focused on some modest tax rises to cover increased spending. The problem with both is that they fail to address how they would avoid the big dose of austerity for most government departments that is pencilled in for the next parliament. 

Labour have proposed almost £5bn extra in public spending, which is more than covered by tax rises of about £8.5bn. The increases in revenue come from imposing VAT on private schools, measures to further tighten the non-domicile tax regime, as well as introducing avoidance measures and extending the windfall tax on oil and gas companies. The big risk here is that the new taxes don’t bring in nearly as much as expected. Behaviour changes with private schools, non-doms or private equity firms could easily cancel out much of the gain from higher rates. What’s more, cracking down on tax avoidance is easy to say, but much, much harder to do. If it were that easy to gain an extra £5bn a year from avoidance, why haven’t the government done it already? Indeed, the OBR has had to massively downgrade its estimates of how much tax can be gained from anti-avoidance measures. 

Labour also pledged to increase investment on green projects by an additional £4.7 billion per year on average, mostly funded from extra borrowing. That’s a step in the right direction, but is almost an order of magnitude smaller than what is needed. For example, a boost of around £30 billion would be needed to keep public sector net investment as a share of the economy in line with its long-run average in 2028-29, which is already too low. 

Meanwhile, the conservatives have focused on tax cuts of around £17bn, the biggest of which is a 2-percentage-point cut in employee National Insurance contributions, which would cost almost £12bn per year. Reform to child benefits so they’re withdrawn based on household income and not that of the highest earner in the household and a promise to make permanent the increase in the threshold at which first-time homebuyers start paying stamp duty to £425,000 from £300,000, make up most of the rest of the tax reductions. We would expect the stamp duty cut to boost demand and house prices modestly. Reducing that tax has been a favourite policy of the current government but the real issue remains a lack of new houses being built.

These tax cuts would be paid for by a £12bn reduction in the welfare bill (excluding pensions I should point out) and reducing tax evasion by £6bn (see above for my thoughts on that). 

The big problem with both manifestos is that the revenue raising measures look overly optimistic and even if they are accurate don’t address the coming squeeze in spending on public services. Indeed, Labour has already left itself a couple of billion pounds of contingency in the form of unallocated fiscal resources. Against its fiscal rules, which allow it to borrow to invest, there is room to spend up to £3.7 billion more than has been planned. However, we estimate a further £20bn would be needed to prevent real term spending cuts in the non-protected departments (everything apart from health, defence, foreign policy and education). 

That means more taxes, more borrowing or a further deterioration in public services, which are already crumbling. Pick your poison! 

  • Inflation back at 2%
  • Bank of England Meeting
  • Retail should bounce back

Inflation back at 2%

Headline CPI inflation is likely to drop again in May to 2% from 2.3% in April. The Bank of England (BoE) pencilled in a reading of 1.9% in its May forecast.

All eyes will be on the services CPI reading, following April’s stronger-than-expected print. We expect annual inflation to ease to 5.5% from 5.9%. We think the risks to our view are balanced - on the one hand data has been surprising to the upside of late, suggesting we may have underestimated the persistence of inflation.

On the other, the price balance of services PMI points to further disinflation. Elsewhere, food and core goods inflation are likely to continue to ease as well.

Core inflation, which excludes volatile components like food and energy, is also likely to drop. We expect a fall to 3.5% from 3.9%.

Looking ahead, headline inflation will probably fall below 2% in June, clearing the way for rates to be cut in August. Our forecast sees inflation averaging 2.2% in the second half of 2024. The equivalent number for the BoE’s projection is 2.4%. We think the softer inflation outlook will give the central bank room to deliver more than the two rate cuts markets expect this year.

Bank of England Meeting

The Monetary Policy Committee (MPC) will almost certainly keep interest rates on hold at its next meeting on Thursday 20 June. We also aren’t expecting any major changes in the committees forward guidance or the vote split. Financial markets are pricing in just a 5% chance of a rate cut next week and the committee will be loath to inject any volatility into markets so close to a general election. 

We expect the first rate cut to come in August, with that being followed by two more to leave interest rates at 4.5% by the end of the year. However, the risk is that the Bank chooses to start later and cut by less. 

In our view, a delay beyond August would be a mistake, even if the data comes in a little hotter than expected. Inflation is back at normal levels, the labour market is clearly loosening and GDP growth is still meagre. A gradual reduction in interest rates would support growth, without risk of reigniting inflation. 

Retail should bounce back

We expect UK retail sales to show a modest bounce after being hit by the unseasonably wet weather in April. 

The pressure on households is likely to ease as wage growth continues to surpass inflation, leaving more change in people’s pockets.

A near-10% rise in the National Living Wage from April will benefit almost three million low-paid workers. That will support the high street as this group tend to have a higher marginal propensity to spend.

Still, consumers may remain cautious about purchasing big-ticket items. A stalling housing market will also curb spending on furniture and other household goods. Talk of the BoE being in no hurry to ease policy will likely make consumers more reluctant to spend as more household’s face larger mortgage payments than they anticipated.

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