Analysis-As tax hit looms, UK employers prepare to push up prices

By William Schomberg

BROADSTAIRS, England (Reuters) - Pub owner Philip Thorley sees only one direction for his prices once a tax hike for British employers kicks in next week: up. That may be bad news for the Bank of England, which plans to lower interest rates to help the sluggish economy.

Thorley, who owns 18 hospitality sites around the seaside town of Broadstairs, said he could not absorb all the extra cost, which follows a painful run of inflation in recent years.

"We feel as though we've been fighting Mike Tyson with one hand tied behind our back," Thorley said as drinkers in his Cramptons sports bar watched cycling and cricket on screens.

"We're not a sponge. At some point we've got to look at it and say enough's enough."

Many business owners are bracing for the 25 billion-pound ($33 billion) hike in employers' social security contributions - announced in October by finance minister Rachel Reeves and which comes into force on Sunday.

Reeves has described her first budget, which included the biggest package of tax increases in three decades, as a "once-in-a-generation" change to invest in public services and modernising the economy.

On Wednesday, she told lawmakers that there were costs to her tax changes but being irresponsible with the public finances would be worse.

The social security hike will be felt keenly in hospitality, where two-thirds of workers are part-time and have mostly earned too little for employers to pay the contributions.

But from the start of the tax year on April 6 the threshold drops sharply, to 5,000 pounds a year from 9,100 pounds for workers aged over 21. The contributions rate will also rise.

At Cramptons, only four of 30 staff outside the kitchen earn more than the existing threshold. From next week, almost all of them will.

"It is going to be really difficult for us ... to swallow this," said Thorley, who employs about 400 people, many of them young workers. "However, we're not going to ... be making knee-jerk reactions. We're going to try to be pragmatic about it."

Thorley recently increased his drinks prices by 5% following an annual price hike by beer suppliers. He expects a similar rise will be needed to cover most of the tax increase.

The British Beer & Pub Association estimates the average price of a pint will go up by 21 pence - taking it above five pounds - due to the tax hike and other changes.

On April 1, Britain's minimum wage went up by nearly 7%, with bigger increases for younger workers.

Hospitality firms are also facing a cut to COVID-era relief from a commercial property-related tax.

HIRING HIT TOO

The difference between labour costs paid by employers and employees' take-home pay - the so-called tax wedge - is lower in Britain than among European peers, a result of decades of government policy to prioritise hiring.

But a push to narrow that difference would not be pain-free.

While some firms are planning to automate more - retailer Currys has said it will replace paper price labels with electronic labelling - most employers are considering less hiring and slower wage increases in response to Reeves' budget.

Steve Hardeman, owner of Clevedon Fasteners which makes parts for construction and engineering firms, said the social security and minimum wage increases were the equivalent of adding two people to his staff of 28.

Rory O'Keefe, commercial director at medical device maker Europlaz, said his firm hired two people on fixed-term rather than permanent contracts and would take three students on short-term placements instead of finding graduates.

The Bank of England is waiting to see what impact the budget changes will have.

Governor Andrew Bailey and colleagues say they expect to keep cutting interest rates after three careful reductions since August, fewer than in the euro zone and United States.

Last month the BoE stressed the uncertainties hanging over the economy. They include the risk of a global trade war, which could cause a slowdown and weaker inflation. That risk grew as U.S. President Donald Trump announced a sharp increase in tariffs on imports from around the world on Wednesday .

BoE surveys of British businesses, however, have shown the most common responses to Reeves' budget will be higher prices and to absorb the hit in profit margins.

Rob Wood, a former BoE economist, said the central bank risked underestimating the price impact of the changes, which were likely to add half a percentage point to an inflation rate already under pressure from other one-off costs, and might even push it above 4% later this year from just under 3% now.

That would be a lot lower than inflation of 11% in 2022 but more than double the BoE's 2% target.

"The Bank of England would normally look through one-off inflation rises," Wood, now chief UK economist at Pantheon Macroeconomics, said. "But one-off or temporary inflation has become a bit of a dirty word since COVID, after central banks misjudged this pretty heavily through 2022 and 2023."

Rising inflation expectations among households and businesses mean the BoE cannot count on pay deal restraint, especially if Reeves' tax increase fuels further price rises.

"If you had to pick a time to make this change, I wouldn't have done it now," Wood said.

($1 = 0.7596 pounds)

(Graphic by Leigh Thomas in Paris; Editing by Catherine Evans)