Your weekly economic update from the team at FXD Capital
On Wednesday, the chancellor’s Spring Statement was a frustrating exercise in obfuscation, will minimal evidence of tangible assistance to households facing a cost of living crunch. The main headlines were cuts to fuel duty by 5p, increases to national insurance thresholds and a 1% cut in the basic income tax band from 2024.
Despite the headlines, the tax rises (e.g. national insurance rates) from last year coming into play still stand, creating a muddling effect where most households will fail to see any immediate impact. Moreover, cutting basic tax rates two years into the future won’t draw any empathy right now and, to some, is seen more as pre-posturing in anticipation of an election year in 2024.
The UK fiscal watchdog, the Office for Budget Responsibility, now forecasts the UK’s tax burden reaching 36.3% of national income by 2025-26, the highest level since World War 2. Pre-Covid, the figure was about 1.5% less, the delta showing the actual cost of lost economic productivity and budget overruns in the intervening years.
The headlines show that the lowest income households will shoulder the burden of tax rises, which is a worrying assumption for the government. Price increases have the most significant impact on that demographic. Still, it’s also one of the simplest to forecast for tax receipts, hence the reticence to offer tax concessions earlier. While higher-income households incur significant income tax burdens, the effect of price increases on their spending is less profound. The increased tax burden also raises the perennial question of whether eventually capital gains and income taxes will be equalised; as wealthier households become, their income power shifts from salaries to equity in assets.
For exchequers, inflation has some nefarious benefits; in that tax receipts, for example, VAT, can be buoyed by price rises. Moreover, based on its forecasts from last year, the treasury actually has a mini-budget surplus right now. Political capital would have been gained by offering some of this back to households. Still, the worry is that the government may be gambling with citizens’ quality of life by holding this card in their deck until it’s closer to an election cycle, where reciprocity at the voting booth will be more immediate.
In other news, the ECB will remove some of the concessions it made on bank funding requirements during the pandemic from July. While the changes will phase out over three years, it will gradually phase out the €240bn of extra collateral permitted by the central bank for repo programs. Some of the collateral impacted will be Greek government bonds, which will lapse by the end of 2024. Such bonds were all the rage about ten years ago, but despite Greece’s stoic efforts to rebuild its economy, their lack of creditworthiness highlights the long road to recovery from debt crises.
Markets had a relatively positive week with stocks rising and bonds under pressure as more clarity regarding the end-game in Ukraine came to light. The S&P 500 is now 7% above its close on the eve before the war started in February. Markets appeared to have priced in the inflation path, which means the markets are reset on that journey and will respond either way depending on how the inflation course plays out. Market threats from the war have shifted from initial armageddon scenarios to now pricing in the havoc caused to food and energy markets from Ukraine’s states and Russia’s jettison from global markets. Peace agreements have been mooted, and Russia’s pace of advance has stalled. The consensus seems split about whether there will be a face-saving withdrawal from Russia or a long-term paralysis of conflict where troops dig in and eke out gains that will reduce marginal attrition.
All the best for the week ahead
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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