Since last autumn’s Budget, things have taken a turn for the worse for the Chancellor. While economic growth has slightly outperformed expectations this year – with GDP rising 0.7% in the first quarter and 0.3% in the second – today’s July reading is uninspiring.
Flat overall with a significant tailing off in industrial production cancelling out a decent increase in construction activity.This is largely as expected. The first half brought forward some activity as businesses shipped goods ahead of the imposition of US tariffs, but now policies on the other side of the pond are a headwind to activity.
The second half of the year promises to be lacklustre. Lack of growth turns spotlight to tax risesA robust economic trajectory is sorely needed to increase the tax take and help balance the books, but the broader context is troubling. The jobs market continues to soften, with rising unemployment and falling vacancies, and stubborn inflation limits the Bank of England’s ability to cut interest rates and support the economy.
The Chancellor’s first Budget included some long-term growth measures, such as increased public investment and looser planning rules, which could pay off over time. But several short-term policies have likely been counterproductive. Increases to the minimum wage and employers’ National Insurance contributions have dented business confidence and hiring. Meanwhile, changes to tax reliefs — particularly those affecting small businesses and farms — have disincentivised investment.With Labour MPs opposed to spending cuts, Ms Reeves has limited room to manoeuvre.
With growth numbers offering limited reassurance about the economy’s scope to meaningfully increase revenue and bond markets wary of any loosening of the fiscal rules, the Chancellor has few options, none of them good. What might the Budget hold?Speculation has grown surrounding niche taxes on pensions, second homes, or financial assets. But these measures are unlikely to raise enough revenue and could further dampen economic activity.
That leaves the major ones subject to previous pledges such as income tax and VAT.In essence, the UK’s fiscal and political constraints appear increasingly irreconcilable: The government may not be able to increase tax revenue without hurting economic growth or breaking manifesto promises. A classic Catch-22.
Rob Morgan, Chief Investment Analyst at Charles Stanley
