Bank of England rate cut only 50-50 after Labour budget - Koutny

Economists now say double rate cut unlikely, one says maybe not even one…

By Matthew Sellers

04 Nov 2024

Even before Rachel Reeves started allowing her budget plans to leak, mortgage intermediaries were concerned that a massive tax and spend raid was coming, and rates started to rise to show that international investors had the same fears. Then she announced her budget – and as people started to digest just what she was proposing, swap rates started rising – adding pressure to fixed mortgage rates. Even the UK Treasury warned that this might happen – and all that talk of 2.75% mortgage rates by the end of next year have gone very quiet.

The Bank of England is still expected to make its second interest rate cut this year as it assesses the new government budget, but from moving from the near certainty of two cuts this year, some experts now see the likelihood of any cut as uncertain. The nine-member Monetary Policy Committee (MPC) is predicted to reduce the base rate by a quarter of a percentage point to 4.75%, after inflation dropped below the Bank’s 2% target to 1.7%. An eight-to-one majority in favour of the cut is expected in Thursday’s decision – along with a rating of what the Bank thinks of Reeves’ budget.

With its latest inflation and growth projections also being released, the Bank will give its first assessment of Labour’s ambitious tax and spending plans, which aim to increase spending by £70 billion annually through a combination of tax hikes and additional borrowing. Investors, initially expecting two rate cuts by the end of the year, have scaled back these forecasts in light of Labour’s budgetary moves.

Matt Swannell, chief economic adviser to the EY Item Club, said he doesn’t expect the recent budget announcement to prevent a November rate cut. “At its September meeting, the Bank of England’s guidance set the stage for another reduction in Bank Rate. Since then, key indicators of inflation’s stickiness — services inflation and pay growth — have continued to fall back more quickly than the MPC had previously forecast,” he explained. Swannell noted these positive inflation trends likely give the MPC enough confidence to proceed with a small rate reduction.

The Office for Budget Responsibility (OBR), however, forecast that Labour’s budget measures would likely raise inflation by 0.6% next year, with a boost in consumer spending delaying a sustainable inflation drop to the target rate of 2% until 2029. “In our view, this [OBR] assessment seems fair,” wrote JP Morgan in a note to clients. “The rise in the minimum wage and higher employer national insurance contributions will likely increase wage pressures, and in turn keep services inflation elevated for longer. It seems like the Bank of England will still press ahead with another 25 basis point cut next week, but this move towards increased government spending could slow their roll on lowering rates in 2025.”

Short-term government bonds, or gilts, have reacted to the budget’s potential to moderate rate cuts. Yields on two-year gilts rose briskly to 4.45% at the end of the week, reflecting reduced investor confidence in near-term rate reductions.

Despite market confidence in at least one rate cut, Ales Koutny, Vanguard’s head of international rates, sees a different picture. “The markets still view a cut from the BoE next week as a given. I see it more as 50-50,” he said on Bloomberg TV, highlighting the Bank may choose to hold rates if it adjusts its growth and inflation outlooks upwards based on the new budget.

“The Bank of England will almost certainly cut interest rates for the second time in this cycle, from 5.00% to 4.75%, at the meeting on Thursday, November 7,” wrote Paul Dales, chief economist at Capital Economics. “But it is unlikely to hint that it intends to quicken the pace by cutting rates again at the following meeting in December. We think there are valid reasons for the Bank to move slower than the ECB and the Fed, including the policies in the UK Budget. That said, we still think rates will fall below the 4.00% priced into the market.”