Confidence can be positively infectious

Speculation is now rife that Reeves’ Budget on 30 October will have to raise taxes to stick within Labour’s self-imposed fiscal rules. Rules that were co-opted from the Conservatives. With a manifesto commitment not to raise Income Tax, employee National Insurance, VAT, or the headline rate of Corporation Tax – taxes that collectively raise two thirds of UK tax revenue - then attention is shifting to whether additional taxes on assets such as property, pensions, and inheritance are in the offing. There is however another way. It was something that Reeves was skilled on in opposition - but shows signs of losing in government. Namely fostering optimism and confidence. Both are now in peril as she pursues a rather politically motivated line that this is the worst economic inheritance since World War Two.

First let’s give Reeves a bit of latitude. The inheritance she has received is far from golden. The public sector debt-to-GDP is at its highest level since 1963. Recent real income growth has been its most sluggish since the early 1950s. Public service productivity remains lower than it was in 1997 despite the extraordinary advances in labour-saving technology over the intervening period. The economy is also having to adapt to trade frictions resulting from Brexit, and the energy market fallout from a war in Europe. And whilst the former Chancellor, Jeremy Hunt, may contest it, some of the legacy bills he left at the Treasury were not appropriately accounted for. A 1997-style legacy this is not.

However to stop there would be incomplete. Economic data is far more encouraging across other aspects of the economy. UK household balance sheets - in aggregate - are in rude health, the unemployment rate is currently lower than in 44 of the last 50 years, inflation is now close to its 2% target, and interest rates are poised to fall further. Business confidence is at an eight year high, consumer confidence at a three year high. Economic growth in the first half of the 2024 was faster than in any other G7 economy. The Pound is at an eight year high. I get that politics doesn’t do nuance very well, but this is a decidedly mixed inheritance.

And when data is mixed the direction the economy takes next can hinge on the tone adopted by economic leaders. In 1997 the New Labour government helped channel these “vibes” in what became known as the era of Cool Britannia.

With many of the same people from that era now back in Westminster should they try to dust off the script? Is this not just an invitation for superficial boosterism? In my opinion there is merit in a much more upbeat message. Three reasons support the idea that a more constructive tone from the Treasury, the Chancellor, and the Cabinet can have positive economic impacts.

Firstly, when looking across data from all major economies since the end of the pandemic it is in the UK where consumers have shown the greatest caution. In the first quarter of the year the UK household savings rate was more than 20% higher than its long-term average. Amongst other G7 economies the savings rate was 26% lower than its long-term average. Given a choice between saving and spending UK consumers remain disproportionately cautious of what is to come. With more confidence - particularly amongst more affluent and older households where much of this additional saving is concentrated - higher consumer spending can fuel a growth and tax receipt upswing that will help offset the need for immediate tax increases.

Secondly, business investment remains subdued with the fallout since the 2016 Brexit referendum meaning a loss of £35bn/year in additional productive assets. Bank of England research released last week suggested that the hurdle rate for investment - the return firms require to justify an investment - is an eyewatering 16%. This is even though additional capital to fund investment remains widely available at single digit interest rates. This suggests that embedded caution remains prevalent across UK businesses. The confidence to lower this hurdle rate and increase total investment will come from a sense in UK boardrooms that things are getting better. The importance of sentiment should not be overlooked by policymakers who may be tempted to look at everything through a tax, subsidy, or regulatory lens. Research by Apella Advisors last year found that just 37% of new intake Labour MPs had private sector experience. This lack of applied experience of what is needed to increase risk appetite, and pursue profit, threatens good judgement on how to increase business investment.

Thirdly, and perhaps most intriguingly, the recovery in economic confidence since the 2022 Mini Budget has been uneven. According to a recent GfK survey consumers are now upbeat - relative to history - about their own finances and the economic outlook. However, when asked about the climate for major purchases they remain cautious. Similarly, whilst business confidence is at an 8-year high according to the Lloyds Banking Group, finance directors are cautious about levels of discretionary spending and are sitting on significant amounts of cash. This all suggests corporate and household sectors that are nervous about potential tax increases, and a resurgence of inflation. Shifting this mindset is key for a recovering UK economy to kick on from a strong start to 2024.

These three data points suggest that the Labour Party’s central mission to accelerate UK growth to the highest in the G7 is within its grasp. But also that it needs careful curation. The doom and gloom of recent messaging is not a costless narrative - even if it fulfils a political purpose. With the honeymoon over it’s time to move on to a positive, more confident message. Done effectively it will help with the financial challenges that will keep landing in the Chancellor’s inbox.