Key Takeaways
- In the run up to July’s general election, the UK economy looked in good shape.
- But now things look different. The economy stalled in Q3 and is expected to remain weak in the final three months of 2024.
- The increase in employers National Insurance (NI) contributions together with other initiatives could dissuade businesses from employing workers.
- Some economists think extra spending could serve to boost growth, but I am not so sure given the knock to confidence from higher NI costs.
- On balance, a recession will likely be narrowly avoided but the outlook remains subdued.
Until Labour swept to power in July, the UK economy seemed to be in good shape. Inflation had fallen to the Bank of England’s (BoE) 2% target, interest rates were set to fall, economic data was coming in stronger than expected and the prospect of continued economic recovery looked good. I felt as optimistic about the UK then as I had all year.
Matters now look very different. The economy stalled in Q3 and seems set to remain weak in the current quarter. Consumer spending, which back in the summer looked likely to provide most of the growth in demand has been weak. Although temporary factors were at work, consumer confidence has reversed its previous upward trend. Business surveys have also weakened. Whereas consensus forecasts for UK growth this year had been steadily revised up, these have more recently been cut. Although the rise in energy prices, with a 10% rise in the OFGEM price cap, have undoubtedly had a role, much of the blame for the deterioration in economic prospects can be traced to Labour’s first Budget. Tax rises were expected, but focussed on wealth, which is generally thought to have a limited impact on demand. In the event, the Chancellor opted for a massive £25bn increase in employers National Insurance (NI) contributions. Coupled with the big increase in the minimum wage and prospective employment reforms, this all represents a big disincentive to employ workers, especially the low paid, the young and any disadvantaged groups.
This steep rise in taxes is needed to finance a big increase in public spending and meet the commitment to reduce the current deficit to zero in three years. Some economists, including the Office for Budget Responsibility believe that the extra spending will more than offset the drag from higher taxes in the next year or so meaning that the economy will actually grow faster as a result of the Budget. I’m not so sure. Such is the knock to confidence from the NI increases, coupled with the other labour market measures that I have mentioned, that unemployment looks set to increase. The NI rises will also raise inflation, putting upward pressure on interest rates. Given the weakness in growth that I expect, interest rates are likely to continue to fall, but the overall mix in the economy looks much less favourable. Indeed, there are already rumours that the Treasury is looking to ‘reprofile’ some of the public spending increases. This would be sensible, especially in areas like capital spending where the prospective increases might simply raise contract prices.
With her first Budget, the Chancellor sought to restore credibility and stability in financial markets and to lay the foundations for a sustainable improvement in economic growth. To my mind, she has achieved neither. There is much more to do. Reversing the steep and unaffordable rise in health and disability benefits would significantly improve the outlook for the public finances. Let’s hope that progress on this and other fronts is made soon. Will we avoid recession? Maybe just, but the outlook is not great.
