Gamble with UK economic growth is not paying off

With a rise in inflation and possibility of a recession, who is to blame as economy struggles under new political leadership?

Britain's Prime Minister Keir Starmer and Chancellor of the Exchequer Rachel Reeves. AFP

That Labour is “failing on its own terms” with the UK economy is emerging as a dangerous consensus facing the Chancellor Rachel Reeves and Prime Minister Keir Starmer after a stream of negative headlines.

Politicians get battered when economies take downward turns, which many say is fair because they also take the credit when the good times roll. In reality, the economy is more swayed by the principles of supply and demand, major geopolitical events and international capital flows.

Chancellors, prime ministers and other national leaders can create an attractive environment for investment where an economy can grow, but there is often debate over exactly how that should happen. And to say downturns are completely their fault would be as false as saying times of stellar economic growth were exclusively a result of their actions. But politicians are happy to take the flak, as long as they can take the credit.

Former Bank of England economist Stuart Cole feels Ms Reeves and Mr Starmer “really do only have themselves to blame” for many of the economic problems the UK is currently saddled with. “Despite all the pre-election talk, the economic policies being pursued are textbook Labour party policies – higher taxes, higher spending, big pay rises for unionised labour, an interventionist industrial policy and return to nationalisation, and all wrapped up in the message that things will get better in a few years time,” he told The National. “Both Reeves and Starmer appear not to have learnt the lessons from the past.”

Some residents of the UK are already voting with their feet, such as tech industry executive Sunil Sharma who proclaimed his new life in Dubai on Tuesday. He said on X that combination of the “UK's decline”, personal ambition and other factors had triggered the move.

Just months into the job of chancellor, Ms Reeves carries a sense of someone walking into the lion's den, be it at the Labour Party conference, where she faced a backlash over stripping pensioner benefits, or at a meeting of the Confederation of British Industry (CBI).

The assembled bosses of Britain's largest companies gave her a muted welcome, for while she has frozen corporation tax, firms face big rises in payroll taxes after she increased employers' national insurance contributions (NICs). In her speech, she reiterated that she had heard the criticism of her budget, but had “heard no alternatives”. She spoke of asking the UK's “wealthiest and businesses to contribute more” and that her £40 billion worth of tax rises were among the “right choices for our country” to dig the economy out of what she had for months called the £22 billion black hole in the national accounts left to her by the previous Conservative government.

As inflation in the UK started a renewed, if weak, upward trajectory in October and November, the Bank of England, having cut interest rates in July and November, decided to leave them on hold at 4.75 per cent at its December meeting. At that meeting, the central bank also revised its growth estimates for the final three months of 2024 down to zero, having forecast 0.3 per cent growth just a month before. The bank said it was “considering the impact on growth and inflationary pressures from the measures announced in the autumn budget, and from geopolitical tensions and trade policy uncertainty”.

Analysts felt the low or no growth scenario coupled with rising inflation leaves the UK at risk of stagflation in the coming months. For monetary policymakers, it is the worst of all worlds – you cannot lower interest rates for fear of stoking already rising inflation, but likewise you cannot lend a hand to the struggling economy by lowering rates either. It is the reason why the Bank of England's monetary policy committee (MPC) was split on their December rate decision by 6-3.

“We continue to think there is a good case for steady monetary policy easing next year, despite the recent hawkish news from wages and inflation,” said Rob Wood, chief UK economist for Pantheon Macroeconomics.

“But the MPC will have to be cautious in the face of inflation likely rising above 3 per cent in the spring, with highly visible price rises that could destabilise inflation expectations that are already above average and rising.”

Following the budget the British media was awash with stories that many of the UK's wealthy non-doms (those non-domiciled in Britain for tax purposes) were planning to leave or had already left because the tax status would be cancelled in 2025, leaving the worldwide assets of non-doms particularly exposed to UK inheritance tax.

While wealth advisory company Henley and Partners predicts the UK will have lost more than 9,500 millionaires in 2024, Andrew Marr from Forbes Dawson described to The National a “perfect storm” for the UK's 74,000 non-doms: the previous Conservative government (whose idea it was to scrap the tax status) “taught everyone how to work location-independently with draconian Covid restrictions”, while the current Labour government has “provided a massive financial incentive to leave”.

Meanwhile, Alexandra Britton-Davis, a tax expert with Saffrey, told The National the new rules will “encourage a greater number of people to retire abroad” and that her firm has “definitely seen an increase in enquiries, from both those planning to stay and those thinking of leaving”.

Debt dilemmas

A wave of worrying data has washed up on Britain's economic shores since Ms Reeves made her budget speech. Inflation was at 2.6 per cent in November, the second consecutive monthly rise. It is now at the same level it was in March and is expected to move higher in 2025, as increased payroll tax costs are passed on to customers in the form of higher prices.

Figures from the Office for National Statistics (ONS) also showed the UK economy shrank by 0.1 per cent in October, having done the same in September. One more monthly decline will put the UK halfway towards a technical recession. Meanwhile, given the Bank of England has yet to fully tame inflation and bring it back to its 2 per cent target, interest rates will have to stay higher for longer.

But the source of some of the UK's economic woes predates the Labour Party's win at Britain's general election in the summer: debt, and specifically the vast amounts of money borrowed during the pandemic years. Because those years were followed by rising inflation and interest rates, that debt is even more burdensome.

Hefty national debt is not just a UK problem either. Guy Foster, chief strategist at Brewin Dolphin, points out that France is in a political crisis because of it, and is expected to borrow 6 per cent of its GDP in its current fiscal year. “France’s challenges are compounded by its membership of the common currency area and the weakness of its political position,” he said.

Russ Mould, director at AJ Bell, feels the UK government is at least recognising the problem and trying to deal with it head-on. “Labour’s determination to flag the national debt as an issue is refreshing, regardless of what you think about the debate over the so-called £22 billion black hole, even if they are getting brickbats for it,” he told The National. “France’s efforts in the same direction have collapsed Barnier’s government and neither candidate really addressed the issue in the US presidential election, even if the federal debt has reached a new all-time high of $36 trillion and the interest bill is now $1 trillion a year on an annualised rate.”

Ms Reeves changed the fiscal rules on debt in her budget by distinguishing between borrowing for investment and borrowing for day-to-day spending, allowing the former and not the latter. Many saw the change as a positive move, because it reduces the ability for the government to simply cut investment spending when money becomes tight. This is something that “people do not notice for many years”, according to Gemma Tetlow, chief economist at the Institute for Government, and “something many previous governments have done, including the last one”.

Borrowing rises

However, because day-to-day spending cannot be funded by borrowing, it must be paid for through taxation. As such, the Chancellor needs a certain amount of headroom in the accounts in order not to return to hard-pressed companies or embattled households for more tax revenue. The Organisation for Economic Co-operation and Development (OECD) has warned that £9.9 billion of fiscal headroom may not be enough to shield the government from unexpected shocks.

Meanwhile, the Treasury has already commissioned the Office for Budgetary Responsibility (OBR) to produce a comprehensive report on the UK economy to accompany Ms Reeves's spring statement. If more money is needed for day-to-day spending, in one way or another the Chancellor will have to raise taxes or cut spending again.

Optimism deficit

By then, the gamble might be that the economy has improved and can take a bit more squeezing. But that is by no means a given. “At the moment I think it is hard to be optimistic that the economy will bounce back in the short term,” Mr Cole told The National. “Business costs have risen sharply, employment prospects have worsened and consumers are facing higher mortgage costs.

“The budget delivered no long-term plan for how all the extra spending announced would be spent. It is all very well throwing money at problems, but unless you have a plan for spending that money efficiently and wisely, then a large chunk of it is likely to be wasted,” he added.

Nonetheless, the OECD's latest forecast has the UK economy growing at 1.7 per cent next year, and it will be the third-fastest growing economy in the Group of Seven advanced nations both next year and in 2026, behind the US and Canada. The “momentum is positive,” the OECD said.

For Russ Mould, 2025 could be a trying time for many economies, not just the UK's. “In a worst case, the UK gets a dose of stagflation, of low growth and sticky price increases, but it may not be on its own in this respect,” he told The National. “And although the world still seems in thrall to US growth, the foundations there may not be all that they seem, given how US government spending and debt accumulation has been a big source of growth in the past four years in particular.”

But for international investor and entrepreneur Dr David von Rosen, the prospects for the UK economy are not fundamentally altering its investment potential. Describing himself as a “natural risk-taker” he told The National that he'll invest in a “good business opportunity, regardless of changes to tax frameworks and domicile statuses”.

“To me, success is defined by the quality of the idea and the grit and hunger of the entrepreneur,” he said. “If I identify these, I’ll likely deploy my capital. Overly zealous tax hikes and attacks on wealth of course play a factor, though. However, I don’t think the UK is at that point yet. In fact, compared to some of its international competitors, the UK’s relative political stability makes it a highly attractive place to invest.

“Now the budget has happened, hopefully the government sits back and lets hungry entrepreneurs do what they do best – build businesses. Compared to the political situation in France and Germany right now, this is one asset the UK really has going for it.”