May 2024 monthly update

Read our May monthly update – a roundup of the latest financial news and economic headlines.

Inflation falls less than expected, weakening rate cut hopes

Britain’s inflation dropped to 2.3% in April; less than the 2.1% predicted by economists. It is a blow to hopes that the Bank of England (BoE) would be ready to cut interest rates as soon as next month. Meanwhile, services inflation, a key way for the BoE to gauge when to lower the cost of borrowing, also overshot investor expectations.[1] It came in at 5.9% according to the Office for National Statistics (ONS).

Andrew Bailey, governor of the BoE, said that an interest rate cut in June is being considered but it is not guaranteed. At the start of May, the likelihood of a cut in June was around 60%, as determined by overnight index swaps, but that has fallen sharply after the ONS released April’s inflation data.[2]

Traders were split evenly on the bet of a rate cut occurring by next month but have curtailed their expectations. They now place the chance of a cut at an estimated 15%. Two-year gilt yields rose 0.13% to 4.43% – the largest daily shift since early April. On the other hand, the pound strengthened 0.3% against the dollar to $1.274 after the ONS publication.[3] Core inflation does not account for volatile prices such as food and fuel. It fell far less than anticipated, coming in at 3.9%. While this is down from last month’s 4.3%, it is above the 3.6% forecast by economists.[4]

Neil Birrell, chief investment officer at Premier Miton Investors, believes that services inflation remains a worry for the BoE. He stated: “UK inflation is following the trend elsewhere and is proving to be more resilient than hoped. It is not getting back to target as fast as the Bank of England would like, which will probably delay the first interest rate cut.”[5]

UK living standards lower than most peer nations since 2010

According to research published by the Institute for Fiscal Studies (IFS), Britain’s living standards have declined when compared to other wealthy nations. Before the 2008 financial crisis, median incomes would have been expected to grow by 30% in the years since 2010. The reality, however, is that British median incomes only grew by a paltry 6%. This is despite rapid growth in employment figures and tax cuts for middle earners.[6]

Britain’s working-age incomes grew at half the pace of the USA (12%) and lags even further behind the 16% gains realised by Germany. Among the 14 countries analysed by the IFS, Britain had sunk to the “bottom of the league”, only outperforming France, Spain, and Greece. It stands in contrast to the 12-year period up to the financial crisis when the UK recorded some of the strongest wage growth.[7]

The study undermines recent claims by Chancellor Jeremy Hunt that Germany, Austria, and Sweden have suffered steeper falls in living standards than the UK. As evidence, he presented a rebound in real wage growth. The IFS, however, found that disposable income for a typical household has remained largely unchanged since 2019. They cite higher mortgage payments, weakening employment, and taxes rising for some groups as factors.[8]

Households on both the highest and lowest incomes have fared worse than pre-2010. Although “absolute poverty” has fallen by 3.4%, this is only a fifth of the speed seen in the 13 years prior. Other measures of deprivation have similarly gotten worse. As an example, the number of working-age civilians reporting that they are unable to heat their homes rose from 4% (1.8m people) to 11% (4.6m).[9]

Meanwhile, more people have been dragged into higher-rate tax bands that have not been increased. Tom Waters, associate director at the IFS, stated that income growth “has been slow for essentially everyone; rich and poor, old and young.”[10]

New pension tax-free lump sum cap could have a catch

The Financial Times reports that high earners should be aware of a new “catch in the small print” when it comes to the Lifetime Allowance (LTA) reforms. The catch may put them at risk of overpaying tax on pension withdrawals.[11]

Last year, the government abolished the LTA, which set a limit of £1.073m on what could be saved in a pension tax-free. As of 6 April 2024, it has come into effect alongside a corresponding move to cap the amount that can be taken tax-free from the fund. This introduced a complication for wealthy pension holders. Previously, the tax-free limit was 25% of the LTA but this is now capped at £268,275 – the new Lump Sum Allowance (LSA). Even though it is possible to take lump sums above this figure, anything above is treated as taxable income.[12]

The new system will consider the tax-free lump sums that retirees have already taken. This is then  scored against the newly created LSA. The recent call for caution comes from experts who urge savers to make sure that they keep records of the tax-free withdrawals they have taken from their pots. If savers do not have records, the HMRC will “estimate” how much has been taken. Those assumed by HRMC to have taken more of their LSA than they have risk losing their tax-free entitlement.[13]

“The problem with the default approach is that it assumes that 25% was taken as a tax-free lump sum every time benefits were crystallised prior to 6 April 2024, which may not have been the case,” argued Abrdn, a pension provider. Furthermore, those in defined benefit schemes may not have wanted to change their guaranteed income into a lump sum. Similarly, older defined contribution schemes could have had guaranteed annuity rates. As such, members might have aimed to use all of their pension to secure the greatest income.[14]

To address the issue, HMRC allows individuals to apply for a Transitional Tax-Free Amount Certificate (TTFAC). This could potentially allow 25% tax-free cash to be taken from future withdrawals whereas otherwise there would be none. The certificate could be a boon for those who have taken less than the LSA from a previous pension and have further pensions still to take. The latter might push them over the new limit.[15]

A financial planner will be able to help you decide if this issue may affect you and how best to address it, as determined by your own, unique pension circumstances.