Bailey Says Labour’s Payroll Tax Complicates UK Inflation Fight

7ubs83k5d1b{k38[hfc52m(a_media_dl_1.png UK Office for National Statistic

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(Bloomberg) — The Labour government’s payroll tax is costing the UK jobs, depressing workers’ earnings and pushing up food prices, Bank of England Governor Andrew Bailey said as he warned that the risks to inflation remain “two-sided.”

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In a speech to the British Chambers of Commerce’s annual conference in London, Bailey said he was “beginning to hear a bit more evidence of adjustments through pay and employment” due to the £26 billion ($36 billion) increase in employers’ National Insurance Contributions that took effect in April.

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“The latest data on pay settlements and pay expectations point to a significant decline in wage growth in the year ahead,” he added, as further evidence of the fallout from Labour’s first budget. 

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Bailey’s remarks expanded on his evidence before the House of Lords on Wednesday and set out the thinking behind his decision to vote with the majority on the Monetary Policy Committee to keep rates on hold at 4.25% last week.

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Rates are on a “gradual downward path,” he stressed, and “evidence that slack is opening up has strengthened, especially in the labor market.” Despite the concerns about a softening jobs market, he remains alert to risks that inflation could prove persistent. The recent pick-up in inflation to 3.4%, largely driven rising energy bills, “introduces some further uncertainty into the near-term outlook,” he said.

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Real-terms pay has risen for 21 months, helping to offset the squeeze on British families during the cost-of-living crisis. An end to the run would be a blow to households but would help the BOE press on with rate cuts. 

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Markets are pricing an 80% probability of a quarter point reduction to 4% next month, which would be a fifth reduction since August last year. Gilts were unchanged after Bailey’s speech.

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However, the decision is being complicated by Labour’s jobs tax and recycling levy, which also came into effect in April, alongside a hike in the minimum wage. Higher employment costs are cooling the labor market but rising food costs pose an upside inflation risk because they are “salient to consumers,” Bailey said. Food prices rose “materially” in May due to “labor costs” and “costs related to new packaging regulation,” he said.

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Tax data suggested employment fell at the fastest pace in five years in May, with more than a quarter of a million jobs lost since the Labour government’s policies were announced last October.

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Britain’s growth outlook is also poor. Uncertainty associated with trade “continues to have an impact on the UK economy,” Bailey added, and it “will grow at a more moderate pace over the coming quarters.”

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“Businesses tell us that heightened uncertainty and a weak demand outlook are weighing on investment intentions. That could point to slower investment over coming months.”

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Slow growth could limit the speed of rate cuts, though, if it reflects persistently weak productivity. Bailey suggested the BOE remains wary of cutting rates too fast in case weak supply triggers inflation.

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“Slower potential supply growth reduces the rate at which economic activity can expand without generating inflationary pressures. Monetary policy has to respect this constraint,” he said.

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Bailey said the BOE is also considering the rising pound. He said recent exchange rate movements have been driven by global disruptions, including investors reconsidering their dollar positions, rather than by differences in interest rates.

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