Life under Labour: what is the macro background for the new Government, their likely budget plans and the impact on the economy?

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Life under Labour: what is the macro background for the new Government, their likely budget plans and the impact on the economy?

After inheriting a dire fiscal position how will Labour deliver economic growth? We take a closer look at their options and plans.

The strength of the UK economy is underappreciated, and in that sense Labour is lucky. However, the fiscal position that they inherit is dire, with both debt and taxes around the highest levels for decades. Without the option to ‘tax and spend’, Labour has preferred to focus on boosting economic growth to deliver on their objectives. Labour’s plans are ambitious and radical, and will be challenging to deliver. In the meantime, to fund these new projects and cover any budget gaps, Labour has a list of new taxes. Having foresworn unpopular increases to basic income tax, taxes on capital are the focus and we review a list of possible and probable targets in addition to those areas already announced.

Forecasts for UK growth rise
Forecasts for UK growth rise

Source: Columbia Threadneedle Investments and Bloomberg as at 05/07/2024

Growth

The UK recovery from last year’s ‘technical recession’ is on the back of a virtuous circle of falling inflation and easing wage growth as real incomes rise. This should encourage UK consumers to reduce their current high level of precautionary savings, providing an additional leg to growth. Interest rates should also start falling this year, with the first cut likely in September if wage inflation continues to trend down. A fly in the ointment is a recent rise in gas prices that could lead to higher energy bills this winter.

We see clear signs of a UK housing market recovery. Even modest house price increases are sufficient to stimulate transactions and support economic activity, as well as boosting consumer confidence.

It is not just the outlook for UK that is improving, with support coming from the global economy. The recovery in Germany has boosted European growth. By contrast, it is the US economy that is more likely to face headwinds, as consumers rebuild savings, but this is likely to slow rather than halt growth.

US saving less, UK saving more

Source: Columbia Threadneedle Investments and Bloomberg as at 05/07/2024. Horizontal lines show pre-covid averages.

Dire fiscal position

After highlighting the underappreciated strength of the UK economy, it is necessary to provide some balance by looking at the dire budget position. The cost of dealing with the Global Financial Crisis and Covid have ratcheted up the level of debt, so it is now almost equal to a whole year’s production.

With interest rates at higher levels, and no expectation that forthcoming cuts will bring interest rates or bond yields back to the levels of the previous decade, the debt costs are an additional burden on the budget. There are, of course, no shortage of other areas that need additional resources, including the government’s new projects, such as a sovereign wealth fund and an energy fund.

The answer from the new Chancellor, Rachel Reeves, is not to raise significant extra taxes, which are already at record highs, but an ambitious plan to boost growth and improve productivity.

Government debt rises to almost 100% of GDP
Government debt rises to almost 100_ of GDP

Source: Columbia Threadneedle Investments and Office for National Statistics as at 27/06/2024

Little room for tax increases

With the level of taxes at historic highs, there is little room for new taxes that will not have counter-productive impact on growth. In any event, the new Labour government does not favour a ‘tax and spend’ policy and specifically ruled out changes to Income Tax and National Insurance.

While the Labour government is keen to fund its new projects and provide additional resources for underfunded government services, it is constrained by a desire to ensure that spending does not come at the expense of economic growth. As a consequence, many new initiatives will be dependent on funding from private capital.

Taxes that Labour said that it would increase include VAT on private schools, tighter rules on overseas residents, extending the energy levy and income tax on private-equity carried interest.

Our best guess of areas that Labour will look to tax to fill inevitable shortfalls in government revenues and additional expenditures in the 2025 budget includes the following.

  • Probable: Excise duties, though road fuel is more likely than alcohol; Capital Gains Tax.
  • Possible: Inheritance Tax (IHT); ISAs; Council Tax additional bands.

…but taxes have also gone up

UK government total receipts, % GDP
Uk government total receipt

Source: Columbia Threadneedle Investments and Office for National Statistics as at 27/06/2024

Labour’s ambitious plans to boost productivity

UK productivity growth has lagged previous levels and also its peers in the years since the Global Financial Crisis. This lack of productivity gains has had a significant cumulative impact on the size of the UK economy.

The new Labour government has an ambitious plan designed to reverse the previous trend and boost growth. That is clearly a laudable objective, but the gains are incremental and will accrue over many years. On the other hand, there will considerable upfront capital costs, unpopular political decisions to be made and, even if things go well, some projects will fail – any of which could derail the whole plan before any gains are visible.

Housing will be the first sector of the economy to see Labour’s ambitious plans for increased growth and greater productivity in action. While it is obviously a sector ripe for improvement, there will still be considerable political costs as ministers override local planning objections, build on the green-belt and navigate the details of making industrial policy.

Public sector productivity growth non-existent
Public sector productivity growth non-existent

Source: Columbia Threadneedle Investments and Bloomberg as at 27/06/2024. Productivity is defined as output per hour of labour input

Summary

A positive economic background is a tailwind for the new Labour government, but the dire fiscal position is a major headwind.

Taxes will inevitably have to rise, but will target capital to spread the burden.

Even if successful, the major results of Labour’s ambitious plans to boost growth will take years to come through. However, housing is set to be the exception and therefore a test case.

11 July 2024
Steven Bell
Steven Bell
Chief Economist, EMEA
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Life under Labour: what is the macro background for the new Government, their likely budget plans and the impact on the economy?

Important information

© 2024 Columbia Threadneedle Investments

For professional investors. For marketing purposes. Your capital is at risk. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. Not all services, products and strategies are offered by all entities of the group. Awards or ratings may not apply to all entities of the group.

This material should not be considered as an offer, solicitation, advice, or an investment recommendation. This communication is valid at the date of publication and may be subject to change without notice. Information from external sources is considered reliable but there is no guarantee as to its accuracy or completeness. Actual investment parameters are agreed and set out in the prospectus or formal investment management agreement.

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

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In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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Important information

© 2024 Columbia Threadneedle Investments

For professional investors. For marketing purposes. Your capital is at risk. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. Not all services, products and strategies are offered by all entities of the group. Awards or ratings may not apply to all entities of the group.

This material should not be considered as an offer, solicitation, advice, or an investment recommendation. This communication is valid at the date of publication and may be subject to change without notice. Information from external sources is considered reliable but there is no guarantee as to its accuracy or completeness. Actual investment parameters are agreed and set out in the prospectus or formal investment management agreement.

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle

Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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