The world’s changed, Rishi...

INFLATION changes everything. It changes the outlook for interest rates. It changes the maths of government finances. It changes not only our own financial position, but also many aspects of our daily lives.

This year will see consumer prices rising by 8 per cent, or at least that is what the Bank of England expects. This will be the highest since 1991, so it is outside the experience of three-quarters of the workforce.

Last week saw the response of the Bank of England and more importantly the US Federal Reserve, both increasing interest rates. On Wednesday, we will see what the Chancellor makes of it all with his so-called Spring Statement, aka the Budget. So what has happened, and what should we look for?

The most interesting thing last week was not the increases in interest rates here and in the US, which were pretty much as expected, but the changed outlook for US interest rates from the Fed members of its rate-setting body, the Open Market Committee. We don’t know what each member thinks, but we can see their expectations as a group. In December, their median expectation was that the Fed’s main rate would be between 0.75 per cent and 1 per cent at the end of this year. Now the median rate works out at just under 2 per cent. For 2023 and 2024, the median is higher still – a little under 3 per cent.

Of course these expectations will change. But what happens in the US will affect what happens here, so my big takeaway is that we should be prepared for the Bank of England’s rates to rise to 3 per cent next year. Think of what that might mean for mortgage rates.

Now to fiscal policy. Thanks in part to higher-than-expected inflation but also to decent growth, the Government’s finances look in rather better shape than they did last October when Rishi Sunak announced his Budget. Inflation increases VAT receipts and higher wages increase National Insurance and income tax takings.

Government costs rise too, especially that of servicing the National Debt, since about a quarter of our debt is index-linked, but the increases in costs lag behind the increases in revenue. So the deficit this fiscal year is going to be around £165 billion, not the £183 billion the Office for Budget Responsibility expected last October.

You may remember that the Chancellor was planning two socking great tax increases this year. One comes from freezing the thresholds on income tax, thereby sucking more people into higher tax brackets. The other is the increase in National Insurance Contributions to fund the NHS and social care for the elderly.

Together they would bring the tax take to the highest level relative to GDP, certainly since the 1970s, and on the calculations of the Institute for Fiscal Studies, since the Second World War. This is not going to happen. It already looked pretty much impossible in political terms and not really necessary in economic terms. What has happened to inflation makes it even less possible and even less necessary.

Politically you can’t clobber people with a huge increase in taxation just at the moment they are facing a huge squeeze on living standards. And inflation is bringing in more revenue than was expected without increasing tax rates.

There is a further twist. Higher inflation also cuts the size of the National Debt relative to GDP, a key measure that governments worry about. Remember those concerns that debt would rise to more than 100 per cent of GDP? I don’t think that will happen now, thanks to the faster-than-expected increases in money GDP. We are inflating away the real burden of the National Debt, just as we did after the Second World War. This is cheating savers, and that is disgraceful, just as it is disgraceful to have bank deposits paying less than 1 per cent when inflation is heading for 8 per cent.

So what will Rishi Sunak do? I think it is screamingly obvious at least to postpone the increases in NICs, maybe abandon them. And there should be some increase in tax thresholds.

He also needs to do more to help with fuel prices, of course. This would mean a climbdown from what the Chancellor planned last autumn, but the world is different now. Inflation is even higher than expected then, and Russia has invaded Ukraine. The famous economist John Maynard Keynes is supposed to have retorted when attacked for changing his mind: ‘When the facts change, I change my mind. What do you do, sir?’

The facts have sure changed since last October.

Chancellor has to postpone rise in National Insurance