Spring statement: Soaring prices to slash real pay by largest amount on record

Interest rates are expected to peak at 1.9 per cent next year, twice what was predicted in October. Last week the Bank of England increased interest rates for a third consecutive time to 0.75 per cent.

Inflation is being driven by higher gas prices feeding into a sharp rise in energy bills, alongside higher prices for fuel and global goods.

“Excess demand in the economy means we expect that much of these cost increases will be passed on to consumer prices” and will only partly be matched by higher wages, the OBR said.

“Barely two years on from the start of the pandemic, the UK faces another set of challenges which it has not had to confront for more than a generation – that of rising geopolitical tensions, energy prices and inflation,” said Richard Hughes, the OBR chairman.

“Inflation is now expected to peak at a 40-year high of 8.7 per cent in the fourth quarter of this year, its highest level since the second oil shock of the late 1970s and early 1980s.”

He said inflation would be “higher for longer” than previously estimated because of gas prices and higher wages pushing up costs. But he expects inflation to fall back to below 2 per cent late next year as energy prices fall.

Take-home pay is expected to fall by the largest amount since records began 66 years ago. Real incomes, or the value of earnings after accounting for the impact of inflation, will fall by 2.2 per cent in the 2022-23 financial year.

Pay is expected to rise by 5.3 per cent this year, up from the 3.9 per cent expected in the last set of forecasts in October, because a shortage in labour supply has given workers the bargaining power to seek better-paid jobs. However, overall spending power will fall as wages fail to keep pace with inflation this year and next, resulting in five years of stagnation in living standards.

The OBR reduced its expectations for growth by 2.2 percentage points to 3.8 per cent this year and the latest projections have the rate of growth falling to 1.8 per cent the following year.

Torsten Bell, chief executive of the Resolution Foundation think tank, said: “It’s hard to overstate the scale of the cost of living crisis coming, with the year ahead bringing the highest inflation in 40 years and the worst income squeeze on record.”

Rachel Reeves, the shadow chancellor, said that Sunak “doesn’t get the scale of the challenge” for families, arguing: “The Conservatives have become the party of high taxation because they are the party of low growth.”

However, the outlook for unemployment, which fell to 3.9 per cent in the three months to January, has been revised down for every year of the five-year forecast.

Forecasters warned that there was unusually high uncertainty surrounding the economic outlook because of the difficulty of predicting the impact of the war in Ukraine.

The cost of government borrowing in the next financial year is set to reach £83 billion, which is four times the level it was last year.

Higher inflation drives up the cost of servicing government debt indexed to prices.

Figures from the Office for National Statistics showed tax receipts of £71.9 billion last month, with the total take this year £37 billion higher than the OBR’s forecast last October.

However, Britain’s borrowing hit £13.1 billion in February, which is more than the £8 billion expected by economists, because of higher debt interest payments linked to inflation.

Spring statement at a glance:

Fuel duty
Rishi Sunak said he was cutting fuel duty for only the second time in 20 years. The reduction of 5p a litre will last for a year.

National insurance
The threshold will be lifted from July. Workers will be able to earn £12,570 before they pay national insurance, up from £9,600. Sunak said this amounted to a £6 billion tax cut for 30 million people. The chancellor announced that the basic rate of income tax would be reduced from 20p in the pound to 19p in 2024.

Household support
The government set up a fund last year to help the poorest households and Sunak said it would be doubled to £1 billion from next month.

Energy efficiency
VAT on energy-saving measures such as solar panels, heat pumps and roof insulation will be cut to zero from 5 per cent for five years.

Allowances
The employment allowance will be lifted from £4,000 to £5,000 on April 6 to help small firms to lower national insurance bills.

Business rates
Business rates relief on green technology will be brought forward by a year to next month. Research and development tax credits will be reformed, and the apprenticeship levy is to be reviewed.

Economic growth
The Office for Budget Responsibility said that the war in Ukraine meant there was “unusually high uncertainty”. It forecast growth of 3.8 per cent this year and 1.8 per cent next year. It expects inflation to average 7.4 per cent.

Sunak gears up for election with £30bn war chest

Two years into the job, the British public is beginning to see the real Rishi Sunak (Mehreen Khan writes). Having been thrown into fighting the pandemic a month into his tenure, his spring statement yesterday was the clearest vision yet of how the 41-year-old wants to be remembered as a tax-cutting chancellor.

Sunak defied pressure to spend on helping households facing historic rises in the cost of living to bank most of the windfalls from higher inflation.

He celebrated tax cuts, some immediate and others stored up for a possible election year in 2024, waving his blue book to cheers from his Tory ranks.

“This had less of the feel of a chancellor responding to crises, and more of one delivering a vision,” Chris Sanger, head of tax policy at the accountancy firm EY, said. The war in Ukraine will slow the pace of the post-pandemic economic recovery and hit households battling the worst bout of inflation since the 1970s. Real disposable incomes will drop by 2.2 per cent next year — the worst annual fall since records began, according to the Office for Budget Responsibility.

Inflation has corrosive effects for spenders, including the government.

Higher prices eat away at people’s benefits and pensions, making them feel poorer. It will also pinch government departments, who get less bang for their buck. But higher prices help Sunak massage the public finances and will bring down the government’s borrowing bill by £50 billion this year.

The pace of geopolitical events is already running far ahead of the government’s ability to protect consumers. The fuel duty cut of 5p is scant relief for motorists facing petrol price increases of 20p in the past three weeks. UK energy bills are in line to double this winter, climbing by £830 in October and more than wiping out Sunak’s £200 autumn rebate for household bills that was announced last month.

There are some unwitting losers from Sunak’s “tax plan” which includes a pre-announced cut to income tax from 20p to 19p in 2024. Graduates will be on the hook due to changes in the thresholds for paying back student debt.

The shift will provide the Treasury with its most lucrative long-term saving of £33 billion over the next five years and help fund the planned income tax cut.

The decision to stick with a national insurance rise next month also shifts the burden from unearned wealth such as pensions and rental income to workers’ salaries. Other stealth measures such as freezing the thresholds for income tax will deliver an additional £20 billion to the government’s coffers. In total, the UK’s tax burden is on course to rise from 33 per cent of GDP last year to 36.3 per cent by 2027 — the highest level since the 1940s. It all points to the chancellor’s true tax-cutting zeal kicking in at the end of the parliamentary term. For now, Sunak is collecting his winnings from healthier public finances to build up a pre-election warchest of £30 billion to be unleashed before voters head to the ballot box.

Rain Newton-Smith, chief economist at the CBI, welcomed Sunak’s promises for more business tax reform but said the private sector was looking for action today to ward off the headwinds from war in Ukraine.

Newton-Smith said: “Sunak has shown he can be a bold chancellor when it matters. He wants to get back to life as normal even as we face a war in Europe. There is always a risk that the best-laid plans get overtaken by events.”