A Taxing Problem

The take-up of electric vehicles (EVs) in the UK is being driven by fleet buyers rather than consumers, and while market share fell last year, according to some estimates, by 2035 EVs could account for over 40% of the cars on our roads. This will create a fiscal headache for whichever party is in government, particularly as the Conservatives and Labour are both trying to demonstrate fiscal responsibility. The challenge for both parties is that the Office for Budget Responsibility (OBR) estimates that the Treasury will lose £15bn in motoring tax duties due to the shift to EVs.

Fuel duty revenues are set to steadily disappear, as the UK moves to an electric fleet, so the Chancellor will need to address this quickly. This will need to be done carefully, as the next government will not want to slowdown the take-up of EVs but equally cannot have a situation where there is no tax on EVs.

Think-tanks and analysts have suggested introducing a road-pricing tax where drivers would pay to use certain roads at different times of the day. Certainly, the technology and infrastructure is there with number plate recognition on major routes, but how would a road toll go down with voters? Drivers are already up in arms over the pot-hole scandal and low traffic neighbourhood schemes.

The loss of fuel duty receipts adds to the list of fiscal problems facing the next government, but will it feature in the election campaign? The OBR suggests Jeremy Hunt has a ‘historically modest margin’ or £9bn of headroom between public sector debt and gross domestic product, assuming an end to the current fuel duty freeze. If fuel duty is extended, this headroom would drop by 50%. There is also the matter of defence spending. Grant Shapps has called for this to rise from a target of 2.5% of GDP to 3%. However, the Royal United Services Institute calculates this would require an additional £157bn by 2030!

Whichever party is in government next year will have to make tough choices between reducing expenditure, raising taxes, or allowing borrowing to rise.

What have we been watching?

It was a big week for leading central banks. The Bank of Japan started the ball rolling by ending its negative interest rate policy, as widely expected. The US Federal Reserve (Fed) then picked up the ball with ‘dovish’ interest rate commentary, which has kept the ‘Goldilocks’ economic scenario on track (no US recession/soft economic landing and interest rate cuts). This helped propel US equities to a fresh all-time high. UK inflation continued to slow and the Bank of England left rates unchanged as widely expected – at least they didn’t drop the ball! The key message that global interest rates have peaked and are on a downward path was underlined by the Swiss National Bank, which became the first advanced economy to cut interest rates.

China said that the US has no right to interfere in the South China Sea – a crucial route for global trade – after Secretary of State Anthony Blinken said Washington stood by its commitment to defend the Philippines.

UK inflation continued to slow, coming in slightly lower than expected in February at 3.4%. Core inflation, excluding food and energy was also slightly lower than expected at 4.5%. While encouraging, the latest numbers were not a game changer for the Bank of England, which left interest rates unchanged at 5.25% for the fifth month in-a-row with the market still expecting the first cut in August, although some are suggesting it may come as soon as June. The ‘flash’ PMI business activity indicator for March dipped from 53.0 to 52.9, but while services activity dropped to 53.4, manufacturing improved from 48.3 to 50.2.

The European Central Bank president Christine Lagarde continues to avoid committing to more interest rate cuts beyond the likely first one in June. ‘Our decision will have to remain data-dependent. This implies that after the first rate cut, we cannot pre-commit to a particular rate path.’ Meanwhile, ‘flash’ PMI business activity indicator showed the Eurozone remains just in contraction, as a pick-up in services failed to compensate for a weaker than expected performance from manufacturing. German manufacturing continues to struggle with a PMI of 41.6.

In the US, the Fed announced no change to interest rates, and on ‘dot plot’ guidance, continues to forecast three interest rate cuts in 2024, each of 0.25%. The Fed nudged its preferred inflation measure, the PCE deflator, guidance from 2.4% to 2.6% but left the forecast for 2025 and 2026 unchanged at 2.2% and 2% respectively. Fed Chair Jeremy Powell re-iterated that cuts remain data-dependent and that it will be a ‘bumpy road’ towards the Fed’s 2% target. Futures are currently suggesting a 60% chance of the first rate cut in June. Meanwhile, growth in business activity slowed a little in March, with the PMI business activity indicator dipping to 52.2. However, while service activity slowed, manufacturing grew at its fastest pace in two years.

In a widely anticipated move, the Bank of Japan (BoJ) ended its negative interest rate policy, raising its short-term policy rate from minus 0.1% to a range of zero to 0.1%. This is the BoJ’s first interest rate rise in 17 years and reflects the ‘virtuous cycle between wages and prices.’ The BoJ still expects ‘accommodative financial conditions’ to be maintained for the time being but will need to come up with a comprehensive exit strategy from its QE policy later this year. Japan’s exports climbed for the third consecutive month-in-a-row in a sign of strengthening demand.

In China, the authorities have accused property developer Evergrande and its founder of inflating revenues by $78bn in the two years before the firm defaulted on its debt. To put this in context Bernie Madoff’s fraud in the US some years ago was $20bn.

Brent oil edged up to $86 on production outages and higher fuel/transportation times driven by Red Sea attacks.

Finally, following last week’s ‘Alpha Bites Power Crunch’ – National Grid’s Electricity Systems Operator (ESO) has said that the UK’s electricity network needs almost a further £60bn of upgrades to hit government decarbonisation targets by 2035. The ESO said some 4,000 miles of undersea cables and 1,000 miles of onshore power lines are needed to get offshore wind power to where it is needed. The investment would add up to £30 to a typical household bill. It will also mean more overhead pylons as putting power lines underground is four times the cost. Hot spots for new pylons are in West Wales and East Anglia and many potentially affected by these are already protesting!

Read Last Week’s Alpha Bites – Power Crunch

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A Taxing Problem

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