Cost of living move is mere plaster on a weeping wound
By Simon French, Chief Economist and Head of Research
The UK government’s primary mission remains promoting faster and more sustained economic growth. So how did this Budget score on that measure? Whilst being mindful that the Office for Budget Responsibility (OBR) is just one of many economic forecasters, it now expects the UK economy to be 7.6% larger by the start of 2029 than it was at the start of 2024. This is down on the 9.4% compound growth over the same time period that the OBR expected before last year’s General Election. Taken at face value, the outlook for UK growth is going backwards under this government’s watch. All this at a time when the tax burden is going up, again, to a level - equal to 38.3% of GDP - last seen in the immediate aftermath of the Second World War.
None of this is to say the government aren’t taking steps worthy of praise. The Budget provided more detail on accelerated planning approval for major infrastructure projects, as well as savings reforms designed to direct capital into UK growth companies. It also showed signs of the government listening to industry on growth-damaging policies like a blunt landfill tax, a poorly targeted business rate regime, and recent deterrents to entrepreneurs coming to, and founding businesses in, the UK. These all speak to noble microeconomic initiatives to address longstanding headwinds to UK economic growth. But these efforts risk being swamped by a public sector that is sucking ever more resources from the private sector for zero productivity gains over the last quarter of a century. Public spending is now expected to average 44.7% of the entire size of the UK economy over the course of this Parliament. That is only 1.5 percentage points shy of the level that triggered an IMF bailout of the UK economy in the 1970s. The lessons from history are not comfortable ones.
The macroeconomic backdrop needs to be more stable for these microeconomic initiatives to bear fruit for Labour. Here the announcement during the Budget of one binding fiscal forecast a year – rather than the current two – and a doubling of the fiscal headroom to £22bn should remove some of the most acute and damaging speculation. Credit to the Chancellor for achieving these important changes and recognising the negative blowback that low headroom and biannual assessment cycles had generated for businesses, and for consumer confidence. Now Rachel Reeves needs to revisit the whole media circus that characterised the run-up to this Budget. Not all of that was of her own making, but only Chancellors can reset the process to be a more orderly affair.
The other macroeconomic upside is that, at first look, this is not poised to be an inflationary Budget to anything like the same degree as was the case last year. The policy measures unveiled at the Budget put downward pressure on regulated prices that total 0.4 percentage points next year. The immediate reaction in Gilt markets was to interpret this as opening a narrow path for the Bank of England to do further interest rate cuts starting in December. But this one-year suppression of consumer prices is a sticking plaster on the weeping wound of the UK economy. Since 2010, UK consumer price inflation has averaged 3.0% a year - a full percentage point higher than the target rate. Whilst the Bank of England must take some of the blame, it has been successive governments that have made the UK supply side more sclerotic. The impact of this loss of competitiveness and flexibility is higher prices for all concerned. The cost-of-living crisis, which had its origins in Ukraine, was amplified by decisions made much closer to home. From Brexit to energy policy, from the relentless rise of the National Living Wage to the prohibitive cost of building homes – these all cast long shadows over the economy that this Budget did little to address. In its Budget assessment, the OBR gave the government a spuriously precise 59% probability of hitting its fiscal rules by the end of this Parliament. Without clear evidence of deep reform to energy markets, to lower the cost of construction, and to reduce the cost of employing people, that probability looks far too optimistic.
Before she stood up, if you had offered the Chancellor the initial financial market reaction to the Budget, she would have bitten your hand off. The work to deliver sustained economic growth, however, looks as far away as ever.
