Why economists are worried about Rachel Reeves’ tax rises

Fears grow that the Chancellor will kill the momentum needed for economic growth

The economy flatlined for the second consecutive month in July, reflecting the scale of the challenge facing new Chancellor Rachel Reeves. 
It marks a stark drop-off from the growth recorded in the first two quarters of the year, at which point the economy was described by the ONS as going “gangbusters”.
Ms Reeves said she was under “no illusion” about the mammoth task to restore Britain’s growth prospects, as she said that “change will not happen overnight”. 
However, there is a growing fear among economists that the Government’s proposed tax hikes, alongside its continued gloomy narrative, will kill off the momentum needed to remove the shackles of stagnation. 
The charts below reveal the obstacles facing Ms Reeves.
Analysts had predicted a small boost of 0.2pc for the UK economy in July, in what would have been an early boost for Labour during its first month in power.
However, this failed to materialise. The economy did not grow at all in July, according to figures from the Office for National Statistics, following a month of zero growth in June. 
Liz McKeown, the director of economic statistics at the ONS, said: “July’s monthly services growth was led by computer programmers and health, which recovered from strike action in June. 
“These gains were partially offset by falls for advertising companies, architects and engineers. 
“Manufacturing fell, overall, with a particularly poor month for car and machinery firms, while construction also declined.” 
This will fuel fears that Britain’s recent bout of stagnation will signal weaker growth in the second half of the year, dampening the 0.5pc expansion recorded from May to July. 
The services sector has been a bright spot for the UK economy over several years, with exports far higher now than they were before Brexit. 
Consumer-facing services grew by 0.1pc overall in the three months to July, when compared with the previous period. Among the biggest boosts were a 4.2pc rise in sports, amusement and recreation activities in July and a 1.7pc rise in the food and beverage sector.
The figures suggest that while England may have experienced yet another year of hurt after losing to Spain in the Euros final, at least there was a small upside for the economy. Gareth Southgate’s efforts failed to inspire growth across the economy, however. 
Barret Kupelian, chief economist at PwC, says: “Growth was widespread across the services sector, partly buoyed by sporting events including the Euros, but was offset by poor performance in the manufacturing and construction sectors.”
Looking at sectors producing goods rather than services, things are looking more shaky. Overall production output fell by 0.8pc in July. Factories also churned out 1pc fewer goods. 
This means both measures are doing worse than at the start of 2022, suggesting high interest rates are weighing on activity. 
Construction also shrank by 0.4pc, despite hopes of lower borrowing costs fuelling a rise in housebuilding.
Isaac Stell, an investment manager at Wealth Club, warned: “A reversal in the fortunes for the manufacturing and construction sectors is a blow to the new Labour Government that has growth as a central pillar of its agenda.”  
Some economists cautioned against reading too much into the figures, which can fluctuate significantly. However, others highlighted how the Government risks killing momentum by failing to portray a sense of hope.
Rob Morgan, chief investment analyst at Charles Stanley, said: “With the Government speaking in a very cautious tone about the economy and warning of ‘difficult decisions’ around tax and spending, it is harder for businesses to retain confidence about the environment going forward.” 
It comes after several warnings from Reeves and Sir Keir Starmer that public finances are far worse than they thought when taking office, paving the way for tax rises. 
In July Ms Reeves said there was a shortfall of £22bn in the public finances for this financial year alone, despite a sizeable chunk of that stemming from generous public sector pay deals that she signed off. Such rhetoric has only intensified as she approaches her maiden Budget at the end of October.
Sir Keir has spoken of things getting worse before they get better, adding that the “broadest shoulders” should bear the heaviest burden. 
If they are not careful then such language could prolong the UK’s economic struggles, claims Lindsay James, investment strategist at Quilter Investor.
She said: “Given the mood music emanating from the Government and the economic inheritance it has received from the Conservatives, it needs to be careful not to overcorrect with its narrative around tax rises and the potential this has to put off investment.”
She added: “Tax rises have been flagged ahead of the autumn Budget, and consumers and businesses may feel rather more cautious heading into the winter months as they await details from the Treasury.”