UK Budget Threatens to Prolong BOE's Fight Against Inflation - BNN Bloomberg

(Bloomberg) — Economists warned that the pain of higher interest rates from the Bank of England could be prolonged after Chancellor of the Exchequer Rachel Reeves announced plans to splurge on spending in her budget on Wednesday.

Reeves has pledged to increase borrowing by £142bn ($184bn) over five years to help fund a major investment program and boost public services, delivering another huge increase in the minimum wage and damaging labor supply; These are all potential threats to the BOE’s growth target. Keep inflation low.

This means the central bank will be cautious about the pace of further interest rate cuts and will lag behind the Fed and the European Central Bank. The first indications will come next week when the BOE will announce its new forecasts and decide whether to cut borrowing costs for only the second time this year.

“It definitely keeps the BoE on a cautious path,” said DeAnne Julius, former rate setter on the Monetary Policy Committee. “There’s a pretty significant net financial easing in this, especially in the first few years, so my sense is that it’s net inflationary.”

The budget is creating a headache for the BOE at a time when Governor Andrew Bailey has said he might consider being “a little more aggressive” on cuts if the good news on inflation continues.

The BOE cut interest rates in August for the first time since the pandemic, and traders are still pricing in another cut on Nov. 7. But they have scaled back bets on a succession move following the budget in December, putting the odds at around one in four. It is stated that there will be no immediate relief for consumers and businesses burdened by borrowing costs, which are close to the highest level in the last 16 years.

The Office for Budget Responsibility has judged that the budget, the first budget of the new Labor government, will increase GDP as well as inflation in the coming years. The financial watchdog warned that the measures would increase price growth by 0.4 percentage points at a peak impact in 2025 and 2026, as borrowing growth and increases in taxes on businesses are potentially passed on to consumers.

It expects inflation to average 2.6% in 2025; This is 1 point above the March forecast and above the 2% target.

RSM UK economist Thomas Pugh predicted that the “expansionary” budget would mean the BOE would have to keep interest rates 25 to 50 basis points higher than they otherwise would be.

St. “This is a net fiscal expansion, but the BOE would be comfortable enough to cut rates once this year,” said Hetal Mehta, head of economic research at James’s Place. But he said this would mean “a more measured pace of cuts” after next week’s meeting.

Swap markets show the BOE is cutting rates of around 100 basis points next year; This is less than the 115 basis points projected for the Fed and ECB’s 119 basis point easing forecast. This was despite the BOE having a slower start to its easing cycle.

Others, including former policymaker Michael Saunders, are more optimistic about the impact it will have on the BOE’s thinking. He said the BOE was likely prepared for fiscal easing, given that the previous Conservative government’s plans relied on massive spending cuts seen as unrealizable.

“Of course there is a slower pace in reducing the budget deficit,” he said. “However, I think you can understand that the MPC may have been as skeptical as everyone else about the March budget plans and may not have fully believed in them.”

Reeves’ plans could increase price pressure on labor market fueling high services inflation

He confirmed that the National Living Wage will increase by 6.7% from April 2025. After two years of huge increases during the cost of living crisis, the pay floor remains at £12.21 per hour; This represents a 29% increase in three years. A figure above the inflation rate.

The new minimum rate is also likely to boost wage growth and raise sticky inflation concerns at the BOE. Businesses increase wages for people already earning above minimum wage; This creates a larger, longer-lasting impact on wages and prices.

Even before Labour’s announcement, ratemakers had warned of “upside risk to payment growth depending on the trajectory of the National Living Wage in the first half of next year” when they met in September.

Kate Shoesmith, deputy chief executive of the Confederation of Recruitment and Employment, said the cumulative impact of pay rises “hurts employers the most”.

He added that a sharp rise in wage bills “could mean workers being offered fewer hours, not taking on a vacant job for a while, or raising prices to consumers.”

–With help from Greg Ritchie.

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