Bank of England's Dovish Stance Unlikely to Ease Budget Challenges for Rachel Reeves

Strategic Insights -

The Chancellor, Rachel Reeves, faces significant challenges in her upcoming Budget in November, with estimates suggesting she may need to find between £20bn and £50bn in tax rises and spending cuts. Despite lower borrowing costs and more support in the debt markets from the Bank of England, the Governor, Andrew Bailey, and his Monetary Policy Committee (MPC) have signaled that interest rates will not be cut significantly in the near future. Inflation, currently at 4%, is expected to rise to 6% later this year, driven by food price inflation, which is a particular concern. This, in turn, may lead to increased pay rises and further inflationary pressures.

Key Takeaways:

  • The Bank of England's MPC has held interest rates at 4% and signaled that significant cuts are unlikely in the near future.
  • Inflation is expected to rise to 6% later this year, driven by food price inflation, which may lead to increased pay rises and further inflationary pressures.
  • The Office for Budget Responsibility (OBR) uses interest rate expectations in financial markets to judge how much debt interest the Chancellor has to pay in the coming years, and the Bank's guidance yesterday is likely to keep this number elevated.
  • The inheritance tax raid on family businesses and farms launched last October has proved painful, with businesses concerned about changes in inheritance tax laws making them less willing to invest.
  • The Bank's decision on quantitative tightening (QT) will continue to be painful for the Chancellor, with the Bank set to sell bonds at a faster pace than last year, which may drive up borrowing costs for the Treasury.
  • The Bank's announcement to slow its sales of long-dated bonds may provide some relief, but the effect is likely to be minimal, and the OBR's calculations will continue to take into account market yields.
  • Businesses are not just suffering from last year's Budget, but are also worried about the upcoming autumn Budget, with sentiment remaining downbeat and many expecting no substantive pickup in activity until 2026.

Statistics:

  • The Bank of England is expected to shrink its balance sheet by £70bn in the year ahead.
  • The Bank will sell £21bn of bonds in the market in the next 12 months, up from £13bn last year.
  • 20 and 30-year borrowing costs have pushed up in recent months due to concerns over long-term government finances.
  • The UK economy is expected to perform poorly, despite which inflation has not slowed down.
  • £20bn to £50bn is the estimated amount needed to balance the budget in the upcoming Budget.

Sources:

  • Bank of England
  • Oxford Economics (Michael Saunders)
  • Office for Budget Responsibility (OBR)