Falling inflation not taxes brings some hope to Tories

There is some good news for the Conservative Party as it scrambles to avoid humiliation at the election

Yes, I know there’s a cost of living crisis, and the airwaves are filled with seemingly endless doom and gloom. Over the past week and more, however, we’ve seen quite a bit of relatively upbeat economic news.

During the second half of 2023, of course, the British economy fell into recession. GDP shrank 0.1pc during the three months from June to August, followed by a further 0.3pc drop during the final quarter of last year.

That’s two successive quarters of economic contraction – the technical definition of recession – the first the UK has seen, outside of lockdown, since the aftermath of the 2009 global financial crisis.

Despite the second-half shrinkage, Britain’s GDP did grow during 2023 as a whole – albeit by just 0.1pc. And there are now clear signs that the economy began to recover in early January – with the latest survey data suggesting economic expansion, though tentative, continued into February and March.

Official data (which may yet be revised) point to GDP growth of 0.2pc during January, boosted in part by buoyant post-Christmas retail sales. On top of that, an influential survey of business opinion last week indicated our main three economic sectors all grew in March – the first time that has happened since June 2022.

What’s most striking is that UK manufacturing just returned to growth, for the first time in 20 months, with production and new orders picking up after prolonged contraction.

The latest purchasing managers index (PMI) survey of business leaders across manufacturing rose to a better-than-expected 50.3 in March, up from 47.5 in February – with readings of 50 or more signalling growth. The survey also found other signs of stabilisation, with falls in manufacturing employment and purchasing activity “slowing sharply”.

Almost three in five manufacturers now expect output to rise in the coming year – the highest since mid-2022, despite ongoing concern at relatively weak export demand and continued supply-chain stresses.

This relative positivity among manufacturers, despite demand for UK exports falling for a twenty-sixth successive month, suggests business leaders now sense a home-grown recovery. As and when UK borrowing costs finally ease in the months ahead, captains of industry are banking on the inherent strength of domestic demand.

This is in sharp contrast to what’s happening elsewhere. The latest manufacturing PMI across the 19-nation eurozone was just 46.1 last month, deep in sub-growth territory. The reading among German industrialists was a truly ghastly 41.6 in March, down from February’s 42.5 – as the EU’s largest economy, having weaned itself off Russian gas, continues to suffer high energy costs.

The EU, in fact, has been the main drag on overseas demand for UK manufactured exports, at a time when ongoing hostilities in the Red Sea hit supplies of Asia-sourced components heading for both UK and EU factories.

Alongside manufacturing, the UK’s mighty service sector – accounting for around three quarters of our GDP – also expanded last month, showing a PMI reading of 53.1. While this was the fifth successive monthly expansion, the reading was slightly down on the previous month – amid strong wage pressures, which led to some slowdown in service sector hiring.

While business and consumer spending remains resilient, industry leaders point to squeezed household and corporate budgets, as well as still-elevated borrowing costs as an ongoing drag on growth. Having said that, confidence continues to build.

The third main sector – construction – also posted a moderate expansion last month with a PMI reading of 50.2, up from 49.7 in February, marking the end of a six-month decline. The biggest boost was in civil engineering but residential building also grew at its fastest pace since November 2022.

The sector remains dogged by political uncertainty and a skills gap but only around a tenth of those surveyed believe construction won’t continue to grow over the next year.

For the Conservatives, of course, even tentative signs of economic progress are manna from Heaven. The Tories’ election strategy – to the extent that they have one – is to delay the general election for as long as possible, while hoping the economy improves. It is no coincidence, then, that Jeremy Hunt, the Chancellor, has recently emphasised that this weekend marks the reduction in the headline rate of employee National Insurance contributions from 10pc to 8pc. This follows the drop from 12pc to 10pc back in January – a combined annual tax cut, the Chancellor says, of some £950 for a worker on the average UK wage of around £34,000.

The Tories have faced criticism that lowering NICs rather than income tax excludes pensioners. And even if they stage another “fiscal event” in October or November, a third tax cut would still be more than offset by the ongoing impact of “fiscal drag”.

With tax thresholds frozen from 2022 until 2028, millions more employees, as wages and prices rise, will be pulled into a higher tax bracket.

Workers, in fact, will lose more than twice from “fiscal drag” what they gain from this 4 percentage-point NIC cut.

Frozen income tax thresholds will rake in an estimated £44.6bn per year by 2028-29, says the Office for Budget Responsibility, equal to a 10 point rise in the headline rate of employee NICs.

Rather than tax cuts that aren’t tax cuts, ministers should stress the easing price pressures. Last week, British Retail Consortium data showed “shop price” inflation fell to 1.3pc in March, sharply down from February’s 2.5pc. While official inflation data for last month won’t be released until April 17, headline price pressures are easing, with the growth of the consumer price index expected to drop again from 3.4pc in February, getting closer to the Bank of England’s 2pc target – with the Monetary Policy Committee now on course to start cutting rates from June.

Ministers point to tax cuts but the MPC’s power to alter borrowing costs give it the most potent cards to play.

‘For the Tories, even tentative signs of economic progress are manna from Heaven’