When the Bank of England published its latest monetary policy report on 6th February, it did Rachel Reeves no favours. Not only did it revise down its expected rate of UK GDP growth in the first quarter of 2025 from 0.4% to 0.1%, it also said that rather than GDP rising in the fourth quarter of 2024, it had actually fallen by -0.1%.
This is a dramatic downturn from the 0.3% growth forecast in the Bank’s November 2024 report. If it’s right, that could mean our economy shrunk in the second half of 2024. If Q1 2025 GDP growth comes up short of the paltry 0.1% forecast, the Chancellor could soon find herself having to explain why she is presiding over a technical recession (defined as two consecutive quarters of negative GDP growth).
Much is made of Liz Truss and Kwasi Kwarteng’s errors in failing to ask the UK Office for Budgetary Responsibility (OBR) to calculate the likely consequences of their infamous September 2022 Budget. Ironically, whilst Reeves didn’t make the same mistake, the OBR’s 205-page report on Labour’s October 2024 Budget is full of gloomy predictions. Here are a few:
- “Budget policies temporarily boost output in the near term, but leave GDP largely unchanged in five years.” (p5)
- “Compared to our March forecast, growth is forecast to be an average of a ¼ percentage point higher this year and next… Growth is then weaker between 2026 and 2028 as these temporary effects fade.” (p8)
- “Over the forecast, business investment falls as a share of GDP as profit margins are squeezed,” (p8)
- “So, by the forecast horizon, government spending comprises a larger part of little-changed real GDP. “(p35)
- “Real business investment is expected to fall 0.6 percentage points as a share of GDP from 2023 to 2029.” (p35)
The OBR report also said that they expected “growth to pick back up in the fourth quarter of 2024 and the first half of 2025” (p32). Bearing in mind that the Bank of England has now downgraded GDP growth for both quarters, it looks like even the OBR’s short-term optimism was misplaced. What went wrong?
I am not a big fan of degrees in Politics, Philosophy and Economics (PPE). They seem to be a favourite among the politically ambitious attending Oxford University (which included Reeves, who graduated from Oxford with a 2.1 in PPE). I see little evidence that the economics part is studied to any great depth. Cameron, Hunt, Sunak and Clegg all studied PPE at Oxford and presided over a decade of low growth and falling productivity. The giveaway to the problem is possibly in the order in which the subjects are listed; politics first, economics last.
To gain power, politicians must convince voters that the UK’s finances will be in safe hands. They do this by blaming the present problems on the profligacy of the outgoing government. Then, once elected, they heap misery on the masses in the form of austerity through higher taxes, lower public spending, or a combination of the two. When things don’t work – as inevitably they don’t – the cabinet of the day blames world events, whilst the opposition criticises the frivolous policies of the sitting government. Meanwhile, to counter the suffocating effects that austerity causes for the economy, the Bank of England cuts interest rates, boosting long-term asset values. Thats great news for the owners of these assets (the rich), but a disaster for working families (the poor) who can’t afford to save or get on the property ladder.
Sadly, Reeves followed her predecessors’ playbook, but with a twist; public sector pay and spending would rise, funded by extra taxes on businesses, including higher employer National Insurance Contributions (NICs) on workers’ salaries, higher rates of Corporation Tax on company profits and Inheritance Tax on family businesses and previously-exempt farms. I surmise that the Chancellor’s advisers convinced her that the negative effects of the extra tax burden would be offset by the positive effects of extra public spending. They were wrong!
Rather than boost growth, as Reeves had hoped, the damaging effects of the October 2024 Budget have quashed optimism and enraged small business owners, farmers and directors of large organisations. C.S. Venkatakrishnan and Stuart Machin, CEOs of Barclays and M&S respectively, wrote pieces in The Times openly pointing out the flaws in Labour’s plans. More recently Alex Baldock, CEO of Currys, heavily criticised the new Employment Rights Bill saying it will hurt the very people it purports to protect. Are they right or are they just protecting the margins of the organisations that pay them? I think they have a point.
In the Sunday Times newspaper issued on 19th January 2025, Venkatakrishnan advocated for policies that restore confidence and risk-taking, and ignite Keynes “animal spirits”. Animal spirits were referenced in Keynes’s 1936 masterpiece, “The General Theory of Employment, Interest and Money”, where the great man said:
“Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities”
“…if animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die”
Keynes means that maths doesn’t matter when people are anxious about the future, because they will not invest and take risks, which are a prerequisite for growth – something Reeves so badly craves. However, if people are fired with enthusiasm, growth will come irrespective of the conditions. Unfortunately for Labour, the Chancellor’s Budget not only failed to fire-up British animal spirits, it also quashed the little bit of optimism that existed last summer. But, there is hope and there is a way out for Rachel Reeves.
The constant stream of bad news about debt and weak government finances spooked households into saving more. As a result, the UK household savings ratio (the percentage of household disposable income saved, not spent) rose to 10.1%, significantly higher than its 7.7% long-term average. UK savings stock also rose, and fast. At the end of 2023, British households sat on net assets, after deducting mortgages and loans, of £11.07 trillion, equivalent to around 442% of GDP. As last year was a period of rising asset values and weak GDP growth, the 2024 figures are likely to be even stronger. This is a rich seam for any government that can unlock its potential, but how do you go about it?
The first thing you don’t do is spook businesses and consumers. Levying extra taxes on UK companies sent them heading for the bunker. As a result, they will cut staffing, spend less and save more. This will weaken employment opportunities and cause households to maintain or increase precautionary savings, decreasing consumer spending.
Keynes remedy for lacklustre demand was to increase government spending, and Reeves has at least broken with her predecessors and grasped the nettle of state underinvestment. But she needs the private sector to help with the heavy lifting of moving our economy forward and her latest tax measures are forecast by the OBR to depress capital investment. The solution on paper is easy – reverse the increases to Employer National Insurance, cut corporation tax to 20% and scrap plans to charge Inheritance Tax on businesses and farms. Animal spirits would quickly revive under a government signalling a different path for Britain and consumer spending and investment would rise, quickly boosting GDP growth, which is the best way to alleviate Government debt.
Unfortunately for the Chancellor, she must keep Labour members happy, and measures that allow companies to keep more of their profits are likely to prove unpopular among many in her party, especially those on the hard left. So the first “P” of the Chancellor’s PPE degree (Politics) will come in handy to inform her, hopefully, on how to square the political circle. Meanwhile, her master’s degree in Economics from The London School of Economics and Political Science (LSE) will help her with the economy (and for the record, contrary to what is being touted in the media, Rachel Reeves is arguably the most qualified person this country has ever appointed as Chancellor).
Britain’s politicians have to come to terms with a modern populace wanting a reliable safety net in the form of a large welfare state. Even the Tories, who in the past regarded themselves as the pro-business and pro-sound finances party, lurched towards a fairer “big society” under Cameron and increased business taxes under Sunak. Conservative Party members can criticise Starmer and Reeves as much as they like for the taxes they levied on business last October, but they started the trend of increases when they could have done something much more imaginative.
Ironically, Kwarteng’s 2022 budget was titled “The Growth Plan”. It advocated keeping Corporation Tax at 19%, reducing NICs, bringing forward a cut in the basic rate of Income Tax and increasing the exemption for the much-despised Stamp Duty Land Tax (SDLT). We will never know whether it would have worked, although the US implemented policies of increased public spending and reduced taxes in recent years, and these seem to have propelled their economy forward at a faster rate than any other major developed country.
Truss is another Oxford University PPE graduate, so she had all the Politics cards at her disposal, but played her hand badly. Kwarteng graduated with a double first in Classics and History before earning a PhD in Economic History, both from Cambridge. He would have known all about Keynes, Cambridge University’s most famous Economics graduate.
So where does the UK economy go from here? Despite struggling under a succession of governments who implemented austerity and failed to boost investment, help may be at hand in the form of unforeseen consequences. Additional taxes on wages make labour more expensive, incentivising employers to cut their workforces through investment in equipment and technology. That will boost productivity, and, unlike in previous cycles, this round of technological advances, including Artificial Intelligence (AI), will reduce service sector jobs as well as those in manufacturing. I am sure this is not what Rachel Reeves planned, but it may be the only thing that saves her.
On my feet at last December’s Annual Client Seminars, I said that I liked both Kwarteng’s September 2022 Budget and Reeves’s October 2024 Budget. Why? Because at least they presented choices – Labour offering higher taxation alongside more state spending, and Kwarteng returning money to consumers to boost demand. They are a contrast and, in fairness to both Chancellors, they were introducing new policies with the objective of boosting growth. But neither set about putting to work the considerable savings UK households and businesses have accumulated.
A little bit of imagination could yield big returns. For example, introducing “British Green Energy Bonds” to fund new, environmentally friendly energy supplies with returns linked to the future revenues generated by the wind, solar, hydro or nuclear facilities they are used to build could work, especially if the bonds come with tax perks, such as being handed to the next generation free of Inheritance Tax. This way, the government shifts the risks to the owners, so they should technically not be regarded as public debt.
The above is just one idea. When you get some clever people working out ways of tapping into, and leveraging (easing regulation, allowing banks that are supporting new energy facilities to match borrowing), an £11 trillion plus pot, you will spark an explosion of activity whilst leaving the world a better place for our children and grandchildren. That is something that all of us, as UK-based investors could, I am sure, buy into, irrespective of whether we sit to the left or right of the political spectrum.
