"This could have implication for the outlook for the pound later this year" - Rabobank on the impact of the National Insurance increase on Sterling's outlook.

Above: File image of Rishi Sunak. Image © Pound Sterling Live, Image courtesy of Parliament.tv

By cancelling - or delaying - planned tax rises, the government could provide the economy with a boost that can underpin a strong start to the year for the British Pound, says a leading foreign exchange strategist.

Jane Foley, Senior FX Strategist at Rabobank, says that although the Pound has started 2022 on a positive note a spike in the cost of living in the UK poses a risk to the outlook.

"We have significant doubts over this outlook... linked to the announced hike in National Insurance tax which will take effect April," says Foley

Despite significant criticism the government looks all but set to hike National Insurance in April in a move some economists say risks compromising consumer spending and confidence, key drivers of the UK economy's dominant services sector.

"This could have implication for the outlook for the pound later this year," says Foley.

Reference rates at publication:

GBP/EUR: 1.2000 \ GBP/USD: 1.3732High street bank rates (indicative): 1.1765 \ 1.3136Payment specialist rates (indicative): 1.1940 \ 1.3365Get a market-beating rate quote, hereSet up an exchange rate alert, hereUnder the plans, employees, employers and the self-employed will all pay 1.25p more in the pound for National Insurance from April 2022 for a year.

"Despite being a sell-proclaimed party of low taxes, the current Tory government is on course to lead the country to its highest tax burden in 70 years by the end of the current parliament," says Foley.

Prime Minister Boris Johnson and Chancellor Rishi Sunak both confirmed on the weekend the hike would precede, despite concerns UK consumers are facing a once in a generation surge in the cost of living.

The implications are significant given the April tax rise comes in the same month the energy price cap is set to rise by 51%, presenting a double dose of negativity for consumers.

After one year the extra tax will be collected under the banner of the Health and Social Care Levy.

The changes to National Insurance will see an employee on £20K a year pay an extra £89 in tax. Someone on £50K will pay £464 more.

Concerns over the future of UK growth are often cited by foreign exchange analysts as one reason for being bearish on the British Pound in 2022.

Foley notes the Pound has made a resilient start to 2022: "without question the pound has been resilient... this resilience owes a lot to market expectations that the Bank of England is likely to hike rates at an aggressive pace this year".

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The Bank is tipped by the market to raise Bank Rate 25 basis points on Thursday, February 03 in what amounts to a second consecutive hike.

A further 100 basis points are priced by the markets for the coming year.

The first 15 basis point hike delivered in December aided a rally in the Pound against the Euro and Dollar over the December and January period.

But, looking ahead, Rabobank sees a risk that, after an anticipated 25 bps rate hike in February, the Bank will struggle to tighten policy further this year which would prove a headwind to support for the Pound from the interest rate expectations channel.

"This outlook is linked to the announced hike in National Insurance tax which will take effect April," says Foley.

The tax faces significant opposition from politicians across the political divide with Conservative MPs making the case for the government to re-consider.

Above: December 2021 borrowing was £7.6BN less than in December 2020 but still £11.0BN more than in December 2019. Chart: Public sector net borrowing excluding public sector banks, UK. Source: Office for National Statistics – Public sector finances.

"They didn’t know at the time that by April we would have the highest inflation rate in 30 years, they didn’t know that interest rates would be going up, council tax would be going up, the fuel price is about to jump by £700 a year for the average family. Therefore, they didn’t know quite what pressure there would be on ordinary people," said David Davis, a senior Conservative MP.

Economists at Rabobank warn of a risk that employers pass the higher cost of National Insurance contributions onto their products, fuelling inflation up from its current 5.4% level.

“The increased cost in employment will mean tough decisions. Some employers will be curtailing pay rises or having to reduce roles or hours. The OBR’s own analysis has shown this. This is unfair and the Government should change course," said Mike Cherry of the Federation of Small Businesses.

The Institute of Directors last week wrote to Sunak asking him to scrap the £12BN payroll tax increase.

Economists also point out there is no immediate necessity to raise takes, given the public accounts are in a better position than the Treasury had expected them to be at this point.

The ONS said last week UK public borrowing was £12.9BN lower than official forecasts in the financial year to December; "our forecasts imply the chancellor would have enough fiscal room to cancel the scheduled increase in national insurance contribution on 1 April to cushion the blow for households,” said Bethany Beckett, economist at Capital Economics.

"On the assumption that the government does proceed with its tax hike in April, we see risk that the market will unwind some of its assumption on BoE rates and this could leave the pound vulnerable in the spring and early summer," says Foley.

Given Rabobank's view that the U.S. Dollar will be buoyed as Fed tightened commences, the bank sees a risk the Pound to Dollar exchange rate could dip below the 1.30 level in the middle of the year.

They scope for a move back towards 0.85 in the Euro to Pound exchange rate on a three to six month view. (Pound to Euro to 1.1765).