The Bank of England recently announced that Rachel Reeves’s first budget as chancellor is expected to cause inflation to rise by up to half a percentage point over the next two years. This increase in inflation is predicted to lead to a slower decline in interest rates than previously anticipated. Despite a 0.25 percentage point cut in the base rate to 4.75%, the Bank’s Monetary Policy Committee (MPC) foresees that inflation will only return to its target of 2% in the first half of 2027, a year later than initially projected.
The MPC noted that the market-implied path for the Bank rate in the UK has shifted significantly since its last meeting. While the Bank’s quarterly Monetary Policy Report indicated that Reeves’s £70bn tax and borrowing measures would stimulate a three-quarter point increase in GDP next year, it is also expected to exert upward pressure on prices.
Governor Andrew Bailey emphasized that despite these projections, there is still progress in disinflation. The MPC voted 8-1 in favor of the interest rate cut, with one member preferring to hold at 5%. The committee believes that rates should be reduced gradually as they monitor the economic response to falling inflation.
The Bank anticipates that inflation will begin to rise in the first half of next year due to various factors, including the addition of VAT to private school fees and the increase in the bus fare cap. The national insurance increase and the national living wage uprating are also expected to impact employment costs, which could lead to higher prices, marginal costs, and wages. However, the exact balance between these effects remains unclear.
Overall, the measures announced in the autumn Budget 2024 are projected to boost GDP by approximately three-quarters of a percent and increase CPI inflation by just under half of a percentage point at their peak. The Bank is obligated to assume the removal of the fuel duty freeze, despite it being maintained by successive chancellors for 11 years.
As inflation remains just below the 2% target, Mr. Bailey emphasized the importance of ensuring that inflation stays close to the target. The Bank will continue to monitor economic developments closely, with the likelihood of interest rates gradually declining further if the economy evolves as expected.
