Oil's return to pre-war levels shifts the outlook

Yesterday, the price of Brent crude oil fell below its level on the day the Iran war began. The benchmark price dropped to US$72.40, from a peak of US$126 in March, crossing a symbolic threshold that suggests investors have now priced out the risk of a sustained, war-driven inflation shock.

Traders now expect one hike from the Bank of England this year, down from two a fortnight ago. Similarly, the ECB is expected to raise rates just once by the end of the year.  

UK mortgage lenders began cutting rates last week and picked up the pace this week, led by Barclays, TSB and Accord Mortgages. “Banks right now are desperate to lend — they haven’t lent as much as they wanted to this year,” Simon Gammon of Knight Frank Finance tells the Times. “Any opportunity they get to lower rates and stimulate activity, they are going to take it.”

Bowing to pressure

Both the pound and the euro have retreated against the dollar as their respective economic outlooks have diverged.

Much of the economic data coming out of the UK and Europe is very weak. The UK services sector contracted in June at the fastest rate in nearly three-and-a-half years. UK manufacturing orders fell at the fastest rate since September 2020, during some of the most uncertain months of the pandemic. Private sector activity in the Eurozone has shrunk for three consecutive months, led by sizeable declines in Germany.

The US economy, by contrast, continues to expand. US businesses reported the largest rise in output since January this month. The Federal Reserve’s favoured inflation metric climbed 0.4% in May, pushing the annual rate to 4.1%, according to figures released this week. Core inflation, which excludes food and energy prices, rose to 3.4% on an annual basis, the highest since June 2023.

Inflation expectations have eased a little despite those figures after new Fed Chair Kevin Warsh vowed to bring inflation under control. Investors had worried that Warsh might bow to pressure from President Donald Trump to cut interest rates prematurely, allowing inflationary pressures to build.

Sheltering middle earners

Tom Bill’s interview with Treasury special adviser James Nation for the latest episode of House Unpacked was a useful lesson in the realities of governing. Recent weeks have seen no shortage of speculation over how Andy Burnham might raise taxes on property and wealth should he become prime minister. Proposals have ranged from a broad wealth tax and aligning capital gains tax with income tax rates to a new land value tax, council tax reform and devolving property tax powers. But many of these ideas have floated for decades, implementation is always complex and modelling often shows that changes don’t raise a great deal, Nation said.

If we step out of the weeds, it’s clear that Burnham would like to continue the trend of asking the wealthiest to pay more, but that looks increasingly unsustainable. The FT had a good piece on Burnham’s desire to shelter middle earners from tax rises yesterday, in which tax lawyer and commentator Dan Neidle points out that the longstanding policy of raising levies on higher earners and financial services giants has “run out of road”. In 2022-23, the top 1% of income taxpayers were responsible for 29% of receipts, up from 21% in 1999-2000, according to official figures quoted in the piece.

If the government continues, wealthy people may respond by leaving the country or changing their behaviour or how they draw their earnings, Isaac Delestre, an economist at the Institute for Fiscal Studies, told the paper. “It’s more risky to load more revenue-raising on a small group than on a broad base,” he added.

Moving abroad

Indeed, Lord O’Neill of Gatley, one of Burnham’s most senior economic advisers, is pushing him to abandon plans for wealth taxes because they can be “easily gamed”, do not raise much money, and deter investment into British companies.

An analysis by HMRC last year found that raising the 24% rate of capital gains tax by ten percentage points would cost the Treasury more than £2 billion by 2028 and £3.5 billion in lost revenues by the time of the next election, according to the Times’ write up of the O’Neill interview.

Turning the screws on the wealthy to balance the books isn’t unique to Britain, and the trend is helping drive wealth migration. I’ve written before about France’s proposal for a minimum 2% annual tax on the assets of individuals worth at least €100 million. That was initially backed by the National Assembly but was blocked by the Senate. Still, a poll published by the Association Française du Family Office covered by Bloomberg yesterday showed that wealth advisers are warning clients to prepare for the possibility of higher levies next year or after the 2027 presidential election. The survey of advisors representing 928 families found that 44% of respondents are considering living abroad.

Separately, Burnham might want to consider a key driver behind the 100%+ rise in luxury house prices in Miami and Palm Beach over the past five years by taking a closer look at California's proposed billionaire tax.

In other news...

City mayors from London to Melbourne seek to curb data centre burden on power, water (Reuters), How to fix the skills shortage in construction? Video games (Times), UK housebuilders warn of ‘shockwaves’ as tariffs on steel imports double (FT), and finally, Social housing plans cut back as UK delays funding (FT).