By Rob Morgan, Chief Investment Analyst at Charles Stanley
Governor Andrew Bailey’s recent comments the BoE could be “a bit more aggressive” with cuts if inflation data remains favourable are now ringing a little hollow. Even before the Budget it was possibly wishful thinking. Services inflation remains worrisome at 4.9% and wage inflation is running at a similar clip. And now the unveiled fiscal policies look decidedly inflationary, as reflected by OBR forecasts that pencil in above-target price rises for both 2025 and 2026.
By lumping additional costs onto employers in the form of extra national insurance costs on top of minimum wage rises, the Chancellor is reinforcing the trend of escalating costs in the worker-heavy services sector, which plays a huge role in the economy. Wage rises and national insurance costs will result in either lower corporate margins or in price increases to the consumer, and we anticipate more of the latter than the former.
There is also the impact that increasing wages for lower earners has on the rest of the employment market. It could have a ratchet effect of lifting wages across the board owing to read across to more senior roles. However, there are cross currents that cloud the outlook significantly. There is now a greater incentive for companies to do more with less and control employment costs through tempering hours worked, bonuses and benefits, or curtailing hires. So unemployment may end up ticking up at the same time as wages, creating losers among the workforce as well as winners from the Budget fallout.
Fortunately, other trends could help ameliorate the Budget inflationary effect. By freezing fuel duty the Chancellor has removed a separate potential driver from the equation, but it does also help preserve greater household spending elsewhere. There are also question marks around how businesses will respond to the budget more broadly and the ramifications this may have for overall economic growth. Those that choose to retrench will become a drag on output, but there are beneficiaries too from increased government spending. There’s a lot to unpick for the BoE economists.
Will interest rates be cut again today? The future trajectory is now more uncertain
Previously, Governor Bailey also stated that “interest rates are going to come down. I’m optimistic on that front”. This much still holds true, and it is highly likely the Bank will continue to follow its data dependent path by cutting rates tomorrow. At a pace of 1.7% year on year consumer prices are presently rising slower than the Bank previously forecast.
However, as the reaction of the gilt market has already reflected, there is now significantly more uncertainty around inflation and interest rates going forward, and overall market expectations have shifted higher. There is also likely to be a wider range of views held by the various members of the MPC. Some may feel the inflationary impacts of additional public spending and extra costs foisted onto businesses are at odds with a further cut for the time being. This will not be enough to delay a rate cut but makes a split in the voting likely at today’s meeting.
It will therefore be particularly interesting to inspect the commentary around the decision making and the BoE’s own interpretation of what Budget policies mean. Justifiably, it may state that there are a range of impacts that are yet to be determined and that it will take time to adequately assess these. However, if it does fall into line with what other forecasters are suggesting then interest rate cuts are going to be shallower, slower and fewer than it previously supposed.
