The standard rate of VAT in Britain increased from 17.5% to 20% today, in a move designed to raise £13 billion a year to help balance the nation's public finances.
UK retailers have warned that the 2.5 percentage point hike will depress consumer spending in the high streets, while there are also fears it will fuel inflation and put upward pressure on pay settlements.
Labour leader Ed Miliband yesterday branded it 'the wrong tax at the wrong time'. But Chancellor George Osborne defended the hike - announced in his emergency Budget in June 2010 - as 'a powerful weapon to tackle debt' and challenged Labour to say what cuts it would make to cover the cost of scrapping it.
Mr Osborne has previously said that the 20% rate is 'not temporary' but a structural part of the tax system, leading economists to predict it will remain at least until the next general election, scheduled for 2015.
Today's rise is the second VAT increase in a year in the UK, after Labour chancellor Alistair Darling restored the 17.5% rate last January having temporarily reduced it to 15% for 13 months to stimulate the economy during the recession.
The change affects any VAT-registered business that sells or purchases goods or services that are subject to the standard rate. Most foodstuffs, children's clothing and books remain zero-rated and reduced rates remain on items such as children's car seats and supplies of domestic fuel and power.
Many UK shoppers are believed to have beaten the rise by buying big-ticket items in the New Year sales over the past few days before the new rate came into effect.
A report by the Centre for Retail Research suggested consumers will spend an average of £324 less in the remainder of this year as a result, cutting UK retail sales by as much as £2.2 billion in the first quarter of 2011 alone.
UK factories surge, but prices a worry
New figures show that UK manufacturing activity grew at its fastest pace in more than 16 years in December and firms' costs rose at a record pace.
The Markit/CIPS manufacturing Purchasing Managers' Index (PMI) rose to 58.3 in December, its highest since September 1994. The headline figure was above the consensus forecast of 57 and November's downwardly revised reading of 57.5.
The index has been above the 50 mark separating growth from contraction since the middle of 2009.
'The UK manufacturing sector saw a truly spectacular end to 2010,' said Rob Dobson, senior economist at Markit and author of the survey. But he pointed to a survey record increase in average input costs.
'Manufacturers in sectors such as clothing, food products and chemicals were hit hard by demand exceeding supply for certain key inputs, as well as rising energy costs,' he added.
Minutes of the Bank of England's latest meeting showed that a growing number of members were starting to worry about a pick-up in price pressures.
The survey showed average input costs rose in December at the fastest rate in the survey's 19-year history, reflecting steep gains in the cost of cotton, food products and energy. Output prices rose at their fastest pace since August and have risen every month for the past year.
The pick-up in manufacturing activity was helped by growth in both domestic and export orders. The new orders index rose at its fastest rate since May, while export orders rose for a third month running and at a rate just shy of the record level registered last April.
Meanwhile, Bank of England figures show that UK mortgage approvals rose unexpectedly in November to their highest level since July.
But the outlook for consumer spending remains uncertain, with the BoE data showing the biggest fall in consumer lending since July and record declines in money supply growth.
British mortgage approvals for house purchases rose to 48,019 in November from 47,315 in October, in contrast to economists' expectations for a slight fall. But November's reading is still well below levels of a year ago and a long-run average of about 90,000 mortgage approvals a month.
Net consumer credit weakened with an unexpected drop of £121m, compared with rises in the previous two months.
A survey released last month by mortgage lender Nationwide showed an unexpected 0.4% increase in house prices in December, but over the year as a whole prices have essentially stagnated.
The headline rate of M4 money supply growth fell in November by a record 1.4% on the year.
