Economic tailwinds mean the next government will have no excuses

The timing of this week’s general election has seemed extraordinary ever since the date was first announced.

Admittedly, there is more to politics than mere economics but the improving outlook makes the choice of a July date all the more quixotic.

It looks likely that the economy will be improving from now to the end of the year – which is when the election could have been held.

If Labour wins on Thursday, it is not going to be able to wheel out the time-honoured excuse of new governments, that is to say: “We have looked at the books and we find things are an awful lot worse than we had been told.”

The big change since Labour was last in power is the establishment of the Office for Budget Responsibility (OBR) in 2010.

It has been producing forecasts of the fiscal position continuously since then.

So the current fiscal situation cannot create any big surprises.

When it comes to the economy itself though, there is plenty of scope for surprises.

And I reckon that most of them are going to be favourable.

The upward revision on June 28 to the first quarter’s GDP growth sets the tone.

Now don’t get carried away.

I am not suggesting that we are about to enter any sort of boom.

It is rather that we are just emerging from a ghastly period when just about everything seemed to go wrong and there was an intense squeeze on living standards.

Against that backdrop, you don’t need the situation to be amazingly good for things to feel a lot better.

The starting point for this improvement is inflation.

It has come down from a peak of 11.1pc in October 2022 to 2pc in the latest figures.

I reckon that there is a good chance that the rate will fall further to about 1.5pc in the next few months.

This is not to say that there is no inflation danger going forward.

Pay inflation has come down only slowly and under a Labour government, the position of the trade unions would probably be strengthened, along with workers’ rights.

There could be a further large increase in both the national minimum wage and the national living wage.

So it is not beyond the bounds of possibility that inflation will resurge at some point and require a further dose of medicine for it to be suppressed all over again.

But for the time being at least the fall in inflation is bringing a big improvement in personal finances.

Real personal disposable incomes may grow by about 3pc both this year and next.

Unsurprisingly, this improvement is leading to increased consumer spending.

Even though official interest rates have not risen any further this year, the previous phase of rising interest rates has continued to exert a drag on households’ spending as people came off previous fixed-mortgage deals and had to refinance at higher interest rates.

This drag is now reaching its peak.

The favourable short-term picture of inflation should allow interest rates to fall a bit, with the first reduction perhaps coming in August.

Against this background, consumers have been cautious and the savings ratio has risen significantly. That may now change.

As people become a bit more confident, they are likely to increase their spending in line with their incomes.

Consumer spending may increase this year by about 1pc and I reckon that it could rise by 2pc next year and in 2026.

Overall GDP should probably increase this year by about 1pc and by about 1.5pc both next year and in 2026.

This is no bonanza but against the mood of gloom and doom that has prevailed over the last couple of years, things will seem a lot better.

These growth rates would be higher than what is experienced in the eurozone, which may grow by only 0.7pc this year and just over 1pc in the following two years.

Yet after the initial wave of euphoria has subsided, Labour will have to confront some harsh realities.

The inflation crisis may be over but the fiscal position will be very tight. The new government could decide to reform the fiscal rules so as to give itself more fiscal headroom.

But I do not think this is likely. And it would not be advisable.

The financial markets would take any such move pretty badly, as they would any attempt to rejig the Bank of England’s mandate, designed to bring looser monetary policy.

The lingering memory of the Truss/Kwarteng debacle should serve as a warning.

Within the fiscal rules, Labour will be able to fund some increased spending by introducing some selective tax rises.

But these will not raise much money.

Realising Labour’s ambitions depends upon achieving faster economic growth.

And that depends upon improving the supply side of the economy, boosting investment and increasing productivity.

This is easier said than done.

Granting further rights to workers and strengthening the position of trade unions won’t help at all.

Perhaps Labour thinks that by cosying up to the EU without actually rejoining it, we will be able to improve business performance here.

If so, it is set for a rude awakening.

The EU is not up for any cosy deal with the UK. If there is any deal to be done, it will be on their terms.

In any case, the EU is in serious trouble economically and politically.

There is no problem to which the solution is to try to become a country member of a failing club.

One area where Labour could make a big difference is the reform of our planning system with a view to increasing the rate of housebuilding.

Mind you, it would take many years of increased levels of housebuilding to make a dent in this problem.

It is possible to transform our economic performance.

But it will take years of hard graft sustained over more than one parliament.

Roger Bootle is senior independent adviser to Capital Economics. roger.bootle@capitaleconomics.com