London’s Economy Today editorial – November 2023
The Chancellor delivers tax cuts, although the tax burden for households is still rising
Higher than expected inflation has increased tax receipts and enabled the Chancellor, Jeremy Hunt, to cut taxes in his Autumn Statement this month – the headline announcement was a 2 percentage point cut in National Insurance contributions (NICs) for employees from 12% to 10% from January 2024. Together with changes to NICs for the self-employed, this is a tax cut for 29 million working people worth £9 billion a year. The Office for Budget Responsibility (OBR) estimates however that overall government revenues will rise sharply to 38% of UK GDP by 2027/28. This rising tax take is in part due to rising inflation. Income tax thresholds, for example, have been frozen to 2028 (announced in November 2022), and will therefore not rise with inflation even as pay increases – this means that a worker pays more tax on their income, even after adjusting for inflation. Low growth has constrained tax raising by means other than higher taxes.
Government revenues are projected to be at the highest share of the size of the UK economy since the second world war. The expected 2027/28 figure still places the UK between the current Organisation for Economic Cooperation and Development (OECD) and G7 averages. Pressures will remain as the population ages and global interest rates remain higher than their historically low levels during the 2010s and early 2020s.
On the expenditure side there was no additional spending for public services to alleviate pressures. This is despite plans for large real-terms cuts in spending to non-protected departments after 2025. The other pressure on spending is rising debt costs. There is a reliance on short-term loans by the Bank of England via its quantitative easing programme, and inflation-linked bonds – the OBR estimates that Public Sector Net Debt (excluding the Bank of England’s debt) will increase from 89% of GDP in 2022/23 to 93% in 2026/27 before falling marginally in 2027/28. Overall, public spending is set to settle at around 43% of GDP in 2027/28, the largest sustained level since the 1970s, if below the peak of 53% of GDP during the pandemic.
The Chancellor also announced 110 measures in his Autumn Statement to improve growth. Notable was to make permanent “full expensing”. This policy enables businesses to write off the entire cost of new plant and machinery against their taxable profits. The aim is to stimulate investment, and the OBR estimates that it will increase output by slightly below 0.2% in the long run. In contrast, the decision to hold capital departmental spending flat means that public sector investment falls as a share of GDP – from 3.6% in 2023/24 to 3.1% in 2028/29. This is likely to have a negative material impact beyond the forecast horizon. Overall, the OBR expects potential output growth to remain weak, at an average of 1.6% between 2024 and 2028, 0.1 percentage points slower than in the March forecast.
The UK economic outlook is little changed
While real GDP growth, that is the growth in output after inflation, has been stronger than the OBR anticipated in March, they expect it to cool over the second half of 2023 with close to zero growth. The Office for National Statistics (ONS) estimates that real GDP grew by 0.2% in September, and 0.1% in August with no growth over the quarter to September 2023.
The OBR now believes that the unexpected strength in the economy earlier this year will be reversed in the coming quarters. This is because interest rates have risen by more than expected in March, and this should weigh on activity. Real GDP growth is forecast to average 1.5% between 2024 and 2027, 0.6 percentage points weaker than forecast in March (Figure 1).
Further, the OBR only expects Consumer Price Inflation (CPI) to hit the Bank of England 2% target in the second quarter of 2025, about a year later than the March forecast (the Bank expects this to happen by the end of 2025). Domestic factors drive most of the upward revision, particularly higher nominal (cash) earnings growth outweighing the effect of lower energy prices.
The labour market is expected to continue to loosen with the UK unemployment rate peaking at 4.6% in the second quarter of 2025, as GDP growth slows and spare capacity opens up. This compares with an unemployment rate of 4.2% in 2023 Q3.
Elsewhere the Resolution Foundation has been looking at household finances over the course of this parliament. They project that the average household will be 3.1% worse off, or £1,900 poorer, as measured by real disposable household income (RDHI) per person, in January 2025 than they were in December 2019. The deterioration reflects the impact of high inflation, poor economic growth, and a rising tax burden. This is the only parliament in 70 years to oversee a decline in living standards. More positively, the OBR estimates that living standards will recover to their pre-pandemic level in 2027/28.
Bank of England holds interest rates as inflation falls
This month the Bank decided to hold interest rates at 5.25% by a majority of 6-3. Three members preferred to increase the bank rate by 0.25 percentage points to 5.5%. The Monetary Policy Committee continues to judge that inflation risks are skewed to the upside. Second-round effects in domestic prices and wages are expected to take longer to unwind than they did to emerge. There are also upside risks to inflation from energy prices given events in the Middle East. There continue to be signs of some impact of tighter monetary policy on the labour market and on momentum in the real economy more generally.
There was a marked fall in CPI inflation last month. In the 12 months to October it rose by 4.6%, down from 6.7% in September. The largest downward contribution came from housing and household services due to gas and electricity – gas costs fell by 31.0% in the year to October 2023, compared with a rise of 1.7% in September. Despite this, the price of gas in October 2023 was around 60% higher than it was in October 2021, and for electricity it was 40% higher. The next largest downward contribution to inflation was from food and non-alcoholic beverages where the annual rate was the lowest since June 2022. The price of food in October 2023 was still around 30% higher than it was in October 2021.
Despite this positive news, measures of underlying inflation, services inflation and core inflation (which omits volatile energy, food, alcohol and tobacco prices) fell by less and remained stubbornly high. These measures are now higher than CPI. Annual services inflation fell from 6.9% to 6.6% from September to October, and for core inflation the fall was from 6.1% to 5.7% (Figure 2).
After two years when this wasn’t the case, for the second month pay (excluding bonuses) was higher than inflation. This was 7.7% in 2023 Q3 in Great Britain, slightly down on previous periods, but still among the highest annual growth rates since ONS comparable records began in 2001. Including bonuses the increase was 7.9%. This was affected by one-off payments to civil servants in July and August 2023.
Meanwhile, Ofgem has announced the latest change to the energy price cap. From 1 January 2024 the price for energy for a typical household who use gas and electricity and pay by Direct Debit will go up by £94. This will take the price cap from £1,834 to £1,928 per year.
Other major central banks also hold interest rates
This month the US Federal Reserve (Fed) held interest rates at a 22-year high. The benchmark funds rate is between 5.25% and 5.5% after 11 increases since March 2022. There may, though, be more for the central bank to do to meet its inflation target, Fed chair Jay Powell indicated. This is because the annual rate of GDP growth to 2023 Q3 was a strong 5.2%, according to the US Bureau of Economic Analysis – driven by a robust labour market and consumer spending. US inflation has been rising at 2.6% in September, after being as low as 1.4% in June.
In late October, the European Central Bank (ECB) held interest rates at 4%, to end a run of 10 consecutive increases in borrowing costs. This is after eurozone inflation more than halved from its peak and the economy showed signs of weakening. ECB president Christine Lagarde would not rule out another rate increase, adding that it was “totally premature” to discuss a potential cut. Eurozone inflation has been falling steadily and is expected to stand at 2.4% in November.
Net migration flows have been rising, although they are set to fall
Total long-term immigration for the year ending June 2023 was 1.2 million, while emigration was 508,000, so net migration was 672,000, according to the ONS. This is down on the estimate of 745,000 for the year to December 2022. More recent estimates indicate a slowing of immigration and increasing emigration.
Before the pandemic migration was relatively stable. Net migration has increased sharply since 2021 because of a rise of non-EU migration of students and workers. This is when new immigration rules came into effect after the UK left the EU. The figures also include people arriving on humanitarian routes (particularly from Ukraine and Hong Kong). The number of EU citizens has been falling from a net inflow of 322,000 in the year to June 2016 (when the EU Referendum took place) to a net outflow of 86,000 in the year to June 2023 (Figure 3).
GLAE Economics analysis reports that London appears to have gained less than the UK from the inflow of non-EU workers and lost relatively more EU workers.
The increase in non-EU immigration in the year to June 2023 was mainly driven by migrants coming for work (up to 33% of the total from 23% in the year to June 2022). This is largely attributed to those coming on health and care visas. In contrast, those arriving on humanitarian routes decreased from 19% to 9% over the same period. The largest contributor to non-EU immigration in the year to June 2023 (39%) was study, which was largely unchanged compared with the previous year.
The Migration Observatory notes that there is considerable uncertainty in migration trends, but estimates that net migration might fall to 300,000 by 2030, roughly similar to pre-Brexit levels. A majority of this decline results from an increase in emigration, offsetting the increase in the inflow observed recently, particularly of international students. A decline in humanitarian immigration also plays a role in the decrease.
City of London office space demand continues to rise
Demand for office space is continuing to rise in the City of London despite the post-pandemic shift to working from home. There has been an increase in jobs, and planning applications are up a quarter on last year – 1,023 to September this year, compared with 820 in the same period last year. More than 500,000m2 of office space is in the planning pipeline alongside a similar amount already being constructed.
Finance still dominates but there has been a 27% increase in tech firms. Legal and insurance companies had led the way back to office use with a focus on in-person training and mentoring. HSBC (finance) and Clifford Chance (law) are also shifting their headquarters to the City from Canary Wharf.
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