Even though Reeves was boosted on Friday by figures revealing an unexpected 0.5 per cent rise in GDP in February, the UK’s economy has remained stubbornly sluggish. And with US tariffs of 10 per cent on British goods – rising to 25 per cent for the key industries of cars and steel – ill global trade winds are yet set to deal a blow to the Chancellor’s plans for growth.
Reeves sipped Earl Grey tea as the pair took stock of what had just happened. More crucially they had to think about “this is what we do next,” according to an aide who travelled with the pair to Jaguar Land Rover’s factory in the Midlands where they addressed a nervous workforce of car manufacturers.
A climbdown by Trump on Wednesday temporarily aligned most countries with Britain’s rate, excluding China, but didn’t provide a reprieve for the UK. But amid a US sovereign debt sell-off, long-term UK government bond yields jumped to their highest since 1998. Sustained increases in UK bond yields may yet wipe out the chancellor’s £10 billion fiscal leeway she rebuilt at her spring statement last month.
“The US tariff announcements are consistent with weaker growth and higher borrowing that would pretty much wipe out the headroom,” Andrew Goodwin, Chief UK Economist at Oxford Economics, told The i Paper.
So, what does Reeves do next? Although some Labour MPs are urging higher borrowing and a tax on the ultra-rich, the consensus among economists is that Reeves will resort to broader taxation to close the anticipated budget gap. The question now centres on which taxes are in her sights.
“I think the big mistake in the autumn was not reversing the employee National Insurance Contribution cuts that happened under the previous government,” Godwin added. “
“That story is a little bit harder to tell now, having not taken the opportunity to reverse them, but that’s probably still the easiest option. Easy is a relative term here; it’s the less difficult one.”
There are no easy options
Adegbembo suggested Reeves’ tax options include relying on fiscal drag to raise revenue by not adjusting thresholds on income tax for inflation. She could also raise capital gains tax on the profit from selling an asset. NICs from employees is something she could examine again, she added.
There are no easy options. While indirect taxes such as a hike on capital gains may be easier to sell politically, Reeves already put the rates up last autumn. Meanwhile, although Labour backbenchers might be satisfied by a wealth tax this too carries a risk of capital flight.
“What you actually see in reality tends to be a lot lower because people make different choices,” Adegbembo said.
In Whitehall officials are more concerned with the here and now, rather than the budget in the autumn: growth is still the central plank of Reeves’ economic plan. “No one credible can say what will happen later this year,” a Treasury source told The i Paper.
When it comes to tax rises, the Treasury is staying tight-lipped. “We’re not going to write four budgets now. No one would do that. No one expects us to do that. The focus right now is got to be getting the deals, supporting the economy and going further and faster,” a spokesperson said.
Caption: UK monthly economic growth (GDP). Infographic PA Graphics.
The Treasury and OBR worked closely together in advance of the spring statement last month to score the National Planning Framework for Homes, which gave a welcome boost to Reeves’ forecasts.
“You can credibly get the OBR back in the room and go, ‘Hang on, we convinced you with this weight of evidence back in February, March. Why aren’t you convinced now when we’ve effectively played the same script back to you, but in a different policy area?’,” French told The i Paper.
At the Treasury, this work is being turbocharged. “There is other supply side stuff we’re doing that we think equally should be considered and scored. So, we’ve got the space now – if we really throw everything we can in the time we’ve got – on the growth stuff now, that makes the conversations with the OBR much the better to have,” a Treasury source said.
Fiscal rules or creative accounting?
On Wednesday, Reeves said she did not consider the economic shock so far to be sufficient to allow her to play her get-out-of-jail-free card and break her fiscal rules. Those rules allow the government to borrow to invest but obliges her to balance day-to-day spending against tax receipts.
According to Kyle Chapman, FX Markets Analyst at Ballinger, if Reeves finds her headroom wiped out come the autumn, “she would need to loosen the fiscal rules or maybe do some creative accounting”.
If she starts early enough and communicates her intentions to borrow more, even foreign bond vigilantes could be encouraged to be more forgiving and not push UK borrowing costs up.
“The risk that we get the worst-case scenario has obviously diminished, though I still believe in tax rises being a likely outcome in October because gilt yields are still sky-high and growth risks are still to the downside,” he added.
Expectations are now fading that the UK can persuade Trump to reduce the 10 per cent tariffs, even as negotiators weigh up whether to allow the president wins by reducing tariffs on US agriculture and abolishing the digital services tax affecting US firms.
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Read More“It is a bad idea with Trump to assume that the uncertainty is ever resolved,” Chapman said. “We still have 10 per cent blanket tariffs, and the markets are watching a big game of chicken between the US and China. That is the epicentre now and it will have far-reaching impacts.”
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