UK Emergency Budget 2010: George Osbourne's Wage Inflation Price Spiral VAT Increase

By: Nadeem_Walayat

George Osbourne, the Coalition governments chancellor looks set to announce deep spending cuts and significant tax rises in tomorrows budget. However what will be the lasting impact of the budget will be the changes to the rate and scope of VAT with the aim of raising at least £15 billion extra revenue per year, that will come to be seen as the budget that sparked the wage price spiral.

The people of Britain have increasingly grown skeptical at the Bank of England repetitive and monotonous month in month out mantra that the surge in inflation to well above 3% is just temporary, nothing to worry about, despite the fact that according to the Bank of England's Inflation forecast of Feb 2010, Inflation for May should have fallen to 2.3% instead it stands at 3.4%, or that the Banks Inflation forecast of Feb 2009 had forecast UK inflation rate of 0.9% by now, which ensures that today's mantra of UK inflation being at 2% in 2 years time is just as likely to be wrong.

An increase and widening in the scope of VAT will near immediately show up on the official inflation statistics, which will propel the CPI inflation rate well above 4% and the RPI inflation rate to above 6% as I originally concluded during the election campaign (05 May 2010 - Greece Economic Depression Resulting in INFLATION NOT DEFLATION Surge )

A post UK election VAT hike to 20% from 17.5% is near certain to bring in extra revenue of about £13 billion per year. This will have the effect of both spiking inflation sharply higher and maintaining the ongoing longer-term inflationary mega-trend, therefore I would not be surprised that following the implementation of a VAT tax hike that CPI spikes above 4% and RPI as high as 6%! Which would further discredit the Bank of England's mantra of "Don't Worry Folks its Only Temporary".

UK Inflation Forecast 2010

UK Inflation of CPI at 3.4% for May is remarkably close to my trend forecast for 2010 as of December 2009 that projected May data of 3.1%. My analysis since November has been warning of a spike in UK inflation as part of an anticipated inflation mega-trend (18 Nov 2009 - Deflationists Are WRONG, Prepare for the INFLATION Mega-Trend ) that culminated in the forecast of 27th December 2009 (UK CPI Inflation Forecast 2010, Imminent and Sustained Spike Above 3%) and the Inflation Mega-trend Ebook of January 2010 (FREE DOWNLOAD) as illustrated by the below graph.

The effect of the VAT hike will be to ignite the wage price spiral that will follow the initial spike higher in UK inflation , i.e. higher wage demands as a consequence of higher inflation rates, especially considering that the RPI rate is already at a high 5.3%, the consequences of which will be that UK Interest rates will also be raised sharply higher as the Bank of England is forced to bring the inflationary wage price spiral under control.

The key question mark is from what date will the expected VAT rise apply from, the earliest is probably the 1st of Jan 2011, with possible the increase being delayed as late as April 2011, which would have the effect of consumers bringing forward spending ahead of the VAT hike so help the economy cushion the impact of spending cuts.

Britians Debt Crisis

The government's annual budget deficit is running at £156 billion a year or at 23% of the total budget i.e. the the governments total revenues are £520 billion against estimated expenditure of £676 billion, hence a deficit of £156 billion added to the national debt known as the Public Sector Net Debt (PSND) currently standing at about £850 billion, though excluding the hidden tax payer liabilities that extend to several more trillions of pounds. Nevertheless £850 billion of debt costs about £35 billion in interest per year to service, as the debt grows so does the cost of servicing the debt, more so as the supply of government bonds increases then so will the market demand ever higher interest rates to buy this flood of debt which illustrates why running anywhere near an £156 billion annual budget deficit is NOT sustainable, as it would ignite the earlier mentioned inflationary debt spiral as interest payments soar which therefore requires urgent action to CUT the deficit to BELOW 6% of GDP / £75 billion, which therefore requires a reduction in the deficit of some £80 billion comprising of tax increases, spending cuts of which possibly £50 billion will be forthcoming in tomorrows budget.

Britain's out of control public sector spending is illustrated by the spending on the NHS which under Labour has grown from £40 billion in 1997 to £121 billion for the last financial year. NHS budgets increasing in line with inflation (CPI) would have seen the budget under a Conservative regime rise to stand at £51.6 billion, and probably nearer £60 billion to allow for an ageing population. So the Labour government was in effect spending an extra £60 billion a year, more than double that which the Conservative would have spent on the NHS.

Rampant out of control public spending under the Labour government has risked bankrupting Britain as the ANNUAL budget deficit now exceeds 12% of GDP (£156 billion) which requires urgent action to prevent igniting an inflationary debt interest spiral i.e. where the interest paid on accrued debt that currently stands at £850 billion (PSND) results in a mushrooming of the countries total debt burden that tips the economy towards an hyperinflationary price spiral economic collapse as the following graphic illustrates.

Emergency Budget Potential Measures

Potential announcements in tomorrows emergency budget include :

• Raise VAT to 20% to raise £13 billion per year from 2011.
• Raise Capital Gains Tax to 40% to raise £1 billion per year.
• Increase Employee NI to 12% from 11% (already announced) to Raise £6 billion
• Increase Tax allowance to £7,475 to cost £4 billion
• Bank Levy to raise £5 billion per year
• Freeze Benefit Payments to cut £4 billion per year.
• Freeze Public Sector Pay to cut spending by £12 billion.
• Other Spending cuts of at least £15 billion of which £6 billion have already been announced.

In total expect at least a £60 billion of spending cuts and tax rises of the estimated £80 billion necessary to reduce the structural part of the budget deficit (not part of the economic cycle).

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By Nadeem Walayat

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Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem's forward looking analysis specialises on UK inflation, economy, interest rates and the housing market and he is the author of the NEW Inflation Mega-Trend ebook that can be downloaded for Free. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 500 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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