Rachel Reeves is finished and more tax pain is on the way: HAMISH MCRAE
The Bank of England won’t put up interest rates at its next rate-setting meeting this week – or at least the cat would really be among the pigeons were it to do so.
Ditto the US Federal Reserve, where its new chair, Kevin Warsh, will be in the hot seat for the first time.
Given the huge uncertainties over the path of the war in the Middle East, a wait-and-see policy just about makes sense, even though the US inflation rate rose in May to 4.2 per cent.
But the European Central Bank took the opposite view last week, increasing its rates in response to inflation in the eurozone climbing to 3.2 per cent last month.
Central bankers move as a herd, and while the ECB is the most important one to have increased rates so far, its counterparts in Australia, Norway and Japan have already started to move.
The US is a special case. The economy is so huge and the dollar still so dominant that it can get away with what would be dangerous fiscal and monetary policies for other countries.
Reeves is clearly finished, so what will the next Chancellor do?, asks Hamish McRae
In 1971, when the dollar was devalued against gold, US Treasury secretary John Connally put the point bluntly, telling fellow finance ministers: ‘The dollar is our currency, but it’s your problem.’
It will do whatever it perceives is best for America, and the rest of us have to live with that.
In any case, there’s a difficulty. When inflation is driven not by excess demand but by what may well be a temporary shortage of supply, it’s tricky to explain why central banks should put up interest rates.
Having the Bank of England force people to pay more for their mortgage does not open the Strait of Hormuz to oil and gas trading. It is energy prices that are the main current driver of inflation.
What more expensive money does do is check second-round effects of more expensive energy, putting pressure on companies to hold down their costs and thereby stopping inflation becoming embedded. But that is not an easy message to get across to the public.
As far as we in the UK are concerned, we will see all this being debated this week. We will also have a fair wodge of economic data, including consumer prices for May, which are expected to be up around 3 per cent.
For what it’s worth, the financial markets are pricing in one quarter point increase in the base rate in the summer or autumn, taking it to 4 per cent by the end of the year.
Actually, the number I will be looking out for will not be inflation but Government borrowing, out on Friday.
Public finances for the first month of the new financial year were dreadful: much higher borrowing than expected.
You should never take one month’s figures too seriously because they are generally revised, one way or the other.
But if we have another bad month that piles yet more pressure on the Chancellor. It comes, to put it politely, at a difficult time for her.
You do not have to be a close follower of Westminster goings-on to see that, whoever ends up as Prime Minister and Chancellor, there are going to be tax rises in the autumn.
What will the next Chancellor do?
My own view is that Reeves is clearly finished, so what will the next Chancellor do? My guess is that they will increase income tax and/or VAT.
They cannot borrow more, with the markets charging the UK a higher rate of interest to service the national debt than any other major economy.
Fiddling with the smaller taxes won’t bring in enough money, even if the whole benefits system is trimmed. Trying to get yet more out of high earners doesn’t work.
The proportion of income tax paid by the top 1 per cent of earners is already falling. It was 29.1 per cent in 2020-21, but down to 26.6 per cent in 2025-26. So those further down the income brackets will end up paying more.
The result of that will be a sluggish economy. Money spent on higher taxes is money that can’t be spent on everything else.
Unemployment is already climbing and will rise further. House prices are already falling.
Faced with this, it may well turn out that the Bank of England doesn’t need to increase rates by much to curb inflation. Things will damp down of their own accord – but not in a nice way.
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