Voters will obviously need to believe that the “economic plan” is working if the Conservatives are to have any chance of winning the General Election. But while it’s not yet showing in the polls, some essential parts of the jigsaw are now falling into place.
Indeed, Labour’s Rachel Reeves appeared worried enough to launch a pre-emptive strike last week, accusing the government of “gaslighting” the public with talk of economic recovery.
Crucially, though, the economy is sparking back to life. The 0.6 per cent growth in national output (GDP) in the first quarter of the year was better than almost anyone had expected. Moreover, the many business surveys which had signalled this bounce were still upbeat at the start of the second quarter.
The Bank of England has also hinted that it is increasingly confident that inflation is heading back to the 2 per cent target on a sustainable basis, and that interest rates can therefore start to be cut soon. One thing still missing is a rebound in consumer spending (real household expenditure rose by just 0.2 per cent in the first quarter). But the foundations for a further recovery are already there.
For a start, consumer balance sheets are in good shape. The household sector as a whole still has large excess savings left over from the pandemic. Household deposits are rising and consumer confidence is recovering, led by a marked improvement in the outlook for personal finances.
The resurgence in wage growth is a key part of this. On Tuesday the Office for National Statistics published the latest labour market data, which showed that regular pay increased by 6 per cent in the first three months of 2024 compared to a year earlier. Adjusting for consumer price inflation, real wages rose by 2.4 per cent in the first quarter. So why has this not yet been reflected in spending?
One possible explanation is that these averages conceal a wide range of different experiences. In particular, the poorer households who are more likely to spend any spare cash are also least likely to have any savings, especially those who spend a larger proportion of their incomes on essentials like rent, food and energy.
But the tide is starting to turn here too. Poorer households will have gained more than most from the large uprating of state benefits and the National Living Wage in April, and from the sharp fall in domestic energy bills. Food price inflation is now easing too.
Consistent with this, the ONS also published some more timely data on wages from HMRC tax records. These show that median pay rose at an annual rate of 6.9 per cent last month, led by even bigger rises in lower-paying sectors such as hospitality, retail and social care.
As it happens, pay in these sectors probably would have risen sharply anyway in response to rising demand and specific labour shortages, even without the hike in the NLW. The end of free movement from the EU after Brexit has contributed too. Nonetheless, the government can at least claim this as a policy success.
Households whose mortgages are coming up for refinancing at much higher rates may still have good reason to be nervous. But many mortgages have already been repriced since interest rates started to rise, and the number refinancing in any quarter is still relatively small compared to the total number of households. Moreover, the improving outlook for inflation means that mortgage rates should not now rise as much as many feared.
Above all, the last few years have also been exceptionally uncertain. Cautious consumers may still want to see the expected falls in inflation and interest rates confirmed before ramping up spending, but the next few months should provide the evidence they need.
By the time of a likely November election, inflation should have been around 2 per cent (or lower) for several months, interest rates will have been cut at least twice (maybe more), real wages will still be rising, and job security should still be relatively high. There is room for one more ‘fiscal event’ too, including another round of tax cuts (perhaps targeting inheritance tax and stamp duty, as well as National Insurance).
Admittedly, the unemployment rate ticked up to 4.3 per cent in the three months to March, but that is still a very low rate. And the silver lining of the cooling in the labour market is that the Bank of England is more likely to look past the jump in headline pay growth and still be willing to cut interest rates soon. In fact, higher pay is part of the solution to the labour shortages that are adding to supply constraints.
Of course, it will still be very difficult for Rishi Sunak to claim enough credit for all this good news – and a strong economy failed to save the Tories in 1997. But the Labour Party will have a much harder job convincing the voters that things can only get better when they are already improving rapidly under the Conservatives.
This piece was first published in the Daily Telegraph on 16 May 2024
Plain-speaking Economics 