MNI INTERVIEW: UK Tax Cuts No Boost To Inflation- OBR's Miles

Tax cuts in this week’s UK budget will boost demand but also labour supply, with a minimal and possibly not even positive overall effect on inflation and scant implications for Bank of England monetary policy, the Office for Budget Responsibility’s David Miles, a two-time Monetary Policy Committee member, told MNI.

While the Budget’s two-percentage-point cut in employee National Insurance Contributions should benefit 27.6 million employees with annual gains of GBP303 for basic rate taxpayers and GBP646 for higher rate ones, it should also “slightly increase” the incentive to work for a large portion of the workforce, said Miles, a member of the OBR’s Budget Responsibility Committee.

“Our view is that it's probably going to increase the size of the labor force by something like 100,000 people. That then increases the supply potential of the UK economy and that increased supply potential comes alongside an increase in demand,” he said in an interview. “The net inflationary effect of that, given that it's has an impact on both demand and supply, we think is pretty minimal. It may not even be positive.”

The official fiscal watchdog cut its inflation projections in the forecasts accompanying the Budget on Wednesday, showing it falling below the BOE’s 2.0% target in the second quarter of this year and averaging 1.5% in 2025, and only rising to 2.0% in 2028.

"I rather doubt that that will have much impact on the Monetary Policy Committee's thinking and their strategy from here on forward," Miles added. Most of the additional labour supply effect will come from additional hours worked, he said.

INCENTIVE TO WORK MORE HOURS

"You only have to have a relatively small effect for each individual (in work) then multiply that by 30 million people and that's where we get the 100,000 full time equivalent increase in the workforce," Miles said. He was less sure of any positive effect on the UK's economic inactivity rate, which has risen in the wake of the pandemic.

"There are reasons to be guardedly optimistic that the situation (on inactivity) may improve, but it's been on an unfortunate trajectory for much of the last couple of years, so much so that a big rise in the inactivity during Covid, which for a while it looked like was being unwound, actually has now reversed again, we've lost about as many people from the workforce as was the case at the height of Covid," he said, pointing to issues such as increased mental health problems among the young. (See MNI INTERVIEW: Better ONS Data Suggest Easing UK Labour Market)

Projected debt interest payments continue to be high and volatile, with public sector net debt-to-GDP forecast to rise to a peak of 98.8% in 2024-25 before declining to 94.3% by 2028-29 The BOE's active sale of gilts and non-replacement of maturing gilts will lengthen the average maturity of UK public sector liabilities from three years at the end of 2023 to seven years by 2028, with the OBR assuming 71% of UK gilts held by the Bank will have been returned to the market by 2028.

LITTLE HEADROOM

The government is only complying with its fiscal rule of reducing the share of public debt to GDP by the end of a five-year period by a 30-basis point margin, which could easily be erased by shifts in market rate expectations, Miles said. (See MNI INTERVIEW: UK Budget's Imaginary Cuts A "Fiscal Fiction")

"When you've got a stock of debt that's not far off 100% of GDP, then 30 basis points movement in interest rates that is sustained (will) after a while feed through to most of the debt. It's worth 0.3% of GDP on government debt interest spending, (or GBP9-10 billion)" Miles said.

"That is the size of our best guess as to what headroom is. And a 30-basis-point change in interest rates that can happen in a day. The sensitivity in the interest cost of the government is a reflection of the fact that the stock of debt is high, relative to GDP.”