Rachel Reeves may count herself lucky that the news this week has been dominated by Donald Trump’s return to the White House rather than the Bank of England’s latest decision on interest rates.
It was always nailed on that the Bank would deliver a November cut in interest rates and borrowing costs have duly been shaved from 5% to 4.75%. Of far more interest was what happens next and here the message was that the budget has made the Bank’s monetary policy committee (MPC) warier about the pace of future policy easing.
The Bank estimates that the increases in spending announced by Reeves last week will mean quarterly growth in a year’s time will be 1.7% as opposed to the 0.9% it was forecasting in August. Inflation, as measured by the consumer prices index, will be 2.7% rather than 2.2% and it will take a year longer, until early 2027, for the government’s preferred measure of the cost of living to return to its 2% target.
Financial markets had been anticipating a relatively rapid fall in interest rates. The investment bank Goldman Sachs, for example, predicted last month that official borrowing costs would fall by a quarter-point at every MPC meeting between now and next November – a total of nine cuts, taking rates down to 2.75%.
There was little in the MPC’s latest quarterly monetary policy report to justify such a view. Andrew Bailey, the Bank’s governor, said the need to ensure inflation remained close to its target meant the MPC couldn’t cut interest rates “too quickly or by too much”.
It will take time for the budget’s impact to become apparent but as the Bank pointed out, the combined effect of Reeves’s measures – particularly the increase in employer national insurance contributions and the national living wage – would be likely to raise the overall costs of employment.
It is possible higher labour costs will be absorbed into the profit margins of firms, hitting their cashflow and leading to an easing of pay growth. But it is also possible the increase in labour costs will be passed on to consumers and so prove more inflationary.
Catherine Mann, the one MPC member to vote for rates to be left at 5%, cited the budget as one reason for her stance. The other eight members thought there had been enough good news on inflation to justify a cut but are adopting a wait-and-see approach. The effects of the shocks that pushed inflation to a peak of 11.1% in October 2022 had abated, but domestic inflationary pressures were “resolving more slowly”, they said.
The latest MPC forecasts for growth and inflation don’t take into account the possible implications of Donald Trump’s victory in the US presidential race, but the result is likely to reinforce the Bank’s gradualist approach. It is not yet clear what Trumponomics will actually entail but, if the president-elect goes ahead with his plan for higher tariffs and tax cuts, the chances are that growth and inflation – in the short-term at least – will be higher.