Labour Government’s dilemma: Growth vs Inflation

Published by Rodney Sutton on 31 July 2024

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‘Our fiscal rules are non-negotiable and will apply to every decision taken by a Labour government.’ So said the Labour Party in its election manifesto and repeatedly since taking the reins of government on 4 July and reiterated by Rachel Reeves in her report on the £22 billion black hole in government spending budget for the current fiscal year.

Yet, as the Chancellor of the Exchequer Rachel Reeves told Parliament, a £22 billion ‘black hole’ in public finances will leave little room to deliver on her party’s election promises. Her mantra was “if we cannot afford it, we cannot have it”.

And if that were not enough, stubbornly high inflation and interest rates continue to hold back the economy. An overall industrial strategy is needed and will take time to get implemented. This strategy will be incorporated in the government spending review and budget.

The Labour Party has made a great play of its ‘five missions’ of government, with its primary mission to ‘kickstart economic growth’ with ‘good jobs and productivity growth in every part of the country’.

It will be a tough promise to keep, with Reeves perhaps wishing for good news when the Bank of England’s Money Policy Committee meet on 1 August.

Interest rates have remained stuck at 5.25% since August 2023, but with CPI inflation now having fallen to the Bank of England’s target of 2% an interest rate cut could be on the cards.

The impact of service level inflation

But CPI is not the only measure of inflation. Service level inflation – a reflection of the UK economy’s reliance on the service economy – remains stubbornly high at 5.7%. It leaves the Bank of England’s MPC finely balanced with a cut in rates questionable.

Economists have been quick to point the finger of blame, with Taylor Swift’s mega UK tour playing to hundreds of thousands across the country and the rising costs of hotel accommodation amongst the many other reasons.

We should not be surprised if the Bank of England leaves the headline rate alone – at least for the time being. However, the higher rates remain a significant barrier to many SME business owners in investing in new opportunities be it in plant and equipment, raising capital for acquisitions of new businesses or improvement in digital resources including AI.

But this will leave the government with a dilemma – what can it do to ‘take the brakes off Britian’ to spur economic growth?

The Bank of England is seen by many as very conservative in its decision-making, and it is widely agreed that interest rate levers to manage inflation are a blunt instrument. But with an eye to the disastrous mini budget from the short-lived Prime Minister Liz Truss, the Labour government will be wary of making bold moves.

And then there is the question of government debt, now standing at around £2.7 trillion, partly a result of the 2008 financial crash and the Covid pandemic.

Government is increasingly hamstrung by the tight fiscal rules of its own making and is set to continue that trend if yesterday’s announcements by Rachel Reeves is anything to go by.

Concern from entrepreneurs

There is increasing concern amongst business entrepreneurs, many of whom are SME’s, that current capital gains tax legislation could be an easy target for the Labour government further dampening business enterprise and growth. The autumn budget on 30th October 2024 will hopefully tell us more.

Government debt is, arguably, low compared to other advanced economies, such as the US, and there is a strong argument that borrowing to promote economic growth is no bad thing. Interest rates present more of a challenge, with the Bank of England’s decision-making independent of government.

Of course, we don’t know what happens behind closed doors, but it does beg the question of whether there are times when the aims of government and the Bank of England need to be a little more closely aligned.

Autumn Budget question time webinar

Following The Chancellor’s Autumn Budget on Wednesday 30 October, we’ll be hosting our Autumn Budget question time webinar during which our panel of experts will be discussing the impact of everything announced by Rachel Reeves. Click here to register your place for our Autumn Budget webinar.

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