A leading British think tank on Thursday said it does not expect the Bank of England to lower interest rates until August, despite the “continued anaemic growth trend” of the UK economy.
On Thursday, the Bank of England left interest rates on hold for the sixth time at 5.25 per cent. The BoE's nine-member Monetary Policy Committee (MPC) voted by 7-2 to keep rates at their highest level in 16 years. Two members of the MPC, Swati Dhingra and Dave Ramsden, voted to lower rates to 5 per cent.
While the Bank of England didn't move interest rates, some saw signals that the MPC is moving towards reducing them, given that Mr Ramsden joined Ms Dhingra, who was the only member to vote for a cut in March, in voting for a cut.
However, some analysts thought the news of an extra MPC member concluding that interest rates should come down immediately was not enough to alter forecasts.
“The BoE doesn’t want to make a premature decision that it ends up having to unwind later in the year, so it could even be Q4 before they feel comfortable to start unwinding their fiscal tightening despite the two votes for a 25 bps (0.25 per cent) cut,” said Mahmoud Alkudsi, senior market analyst at ADSS.
The National Institute of Economic and Social Research forecast only two interest rate cuts this year, to settle at 4.75 per cent, reflecting a “cautious unwinding of monetary policy given the upside risks posed by persistent core inflation, elevated wage growth and geopolitical challenges”.
Nonetheless, investment strategists Bill Papadakis and Luca Bindelli at Lombard Odier expect a 1 per cent fall in interest rates by the end of the year, to 4.25 per cent.
The cutting will possibly start in June, “with a weakening labour market expected to bring down wage growth and high services inflation”, they said.
Others see the Bank of England as having far more hawks than doves, and say turning one into the other on the MPC will be a much longer process than some are forecasting.
“There is no chance the Bank of England will cut rates this summer,” Samuel Mather-Holgate, an independent financial adviser at Mather and Murray Financial told Newspage.
“Their decisions have confirmed that they are not forward-looking and will only respond once inflation is below target. This means there will only be one cut this year, and that’s bad news for the UK businesses, households and the broader economy.”
Inflation to drop below target
The NIESR also expects inflation in Britain to fall below the Bank of England's 2 per cent target in April driven by a fall in the energy price cap. However, they expect that stubborn core inflation will have to fall by much more than it has so far.
The Consumer Prices Index rose by 3.2 per cent rose in March, down from 3.4 per cent in February, figures compiled by the Office for National Statistics show.
But core inflation (which strips out energy and food), was still higher at 4.2 per cent in March, down from 4.5 per cent in February.
“The big factor causing hesitation is the prospect that the 10 per cent hike in the minimum wage, which took effect last month, will lead to a broader increase in wage inflation,” said Steven Bell, chief economist, Europe, Middle East and Africa, at Columbia Threadneedle Investments.
“Yes, the three-month on three-month rate will rise but that should be a one-off.”
On economic growth, the NIESR forecasts gross national product growth of 0.8 per cent in 2024, higher than recently downgraded forecasts from the Organisation for Economic Co-operation and Development and the International Monetary Fund. Nonetheless, the NIESR said “geopolitical risks from the conflict in the Middle East present substantial downside risk” and that “the trend growth rate of UK GDP is only 1 per cent”.
The think tank also said the winner of the next UK general election, expected later this year, will have to raise taxes simply to maintain the current levels of public service spending. In addition, the current Conservative government has no “fiscal headroom” to make any further tax cuts before the election.
“Despite the welcome fall in inflation, UK growth remains anaemic,” said Prof Stephen Millard, deputy director for macroeconomic modelling and forecasting at the NIESR.
“This will make it difficult for any incoming government to carry out the much-needed investment in infrastructure and the green transition, as well as increase spending on public services and defence, without either raising taxes or rewriting the fiscal rules.
“This makes clear the need to reform the fiscal framework to enable the government to do what is needed for the economy in a fiscally sustainable way.”
'Change the fiscal framework'
What that would mean is a complete overhaul of the fiscal rules, which were laid down in the late 1990s, whereby governments only borrow to invest and not to fund current spending (better known as the 'golden rule'), and that the ratio of public sector net debt to GDP would not exceed 40 per cent of GDP.
However, successive governments have broken the debt-to-GDP ratio rule since the 2008 global financial crisis and it now sits at about 98 per cent.
So, the logic becomes: rather than battling to win a losing game, change the rules of the game itself given that, as the NIESR points out, the rules inadvertently prevent good fiscal decision-making by “constraining the public investment needed to improve economic growth and ensure the United Kingdom meets its net-zero target by 2050".
“We are currently missing fiscal targets,” Prof Millard said.
“If you want to hit the fiscal target, you have to literally raise taxes. The most efficient way of doing that is through sticking a penny or two or three on income tax.
“I don't think they should do that though. I think what they should do is change the fiscal framework.
“It's the targets that are creating the problem; it's the targets that are forcing governments to put brakes on the economy. If those targets weren't there, we could have the additional public investment, and we could have more targeted support for lower-income households.
“They need to change the framework. That's the message.”
