Policymakers at the Bank of England are getting ready to lower interest rates and lower their projections for economic growth, which might pose a threat to Chancellor Rachel Reeves’s next budget proposals.
Why is the Bank of England Cutting Interest Rates?
The nine-member monetary policy committee (MPC) is anticipated to reduce the Bank of England’s interest rate by 0.25 percentage points to 4.5%, the lowest level since June 2023, as inflation continues to decline. Alongside this rate drop, the central bank will publish its quarterly evaluation of the state of the economy. It will also reduce its 2025 GDP growth estimate from 1.5% to about 1%, according to economists.
The cut in interest rates is generally anticipated, as the Bank continues to assess the status of the economy, notably the inflation rate. According to several analysts, the MPC’s decision to lower rates was prompted by weaker economic forecasts.
How Do Government Policies Change in Response to the Bank of England's Growth Forecast?
A lower growth estimate from the Bank of England would probably cast doubt on the Office for Budget Responsibility (OBR), which is in charge of the government’s fiscal policy, according to James Smith, an analyst at ING. “To ascertain whether the Chancellor is on track to meet her self-imposed fiscal targets, the OBR’s updated growth forecast is essential,” Smith stated.
Earlier this week, Chancellor Rachel Reeves received the first version of the OBR’s revised growth prediction. This will establish whether the government’s fiscal objectives are still attainable, especially with regard to spending and economic targets.
What Dangers Come with Violations of Fiscal Rules?
Her colleagues, particularly Darren Jones, the chief secretary to the Treasury, have repeatedly stated that they do not consider Reeves’ fiscal standards flexible. The Chancellor might have to make cuts to her budget plans, nevertheless, if the revised OBR projections indicate that she could potentially miss her fiscal requirements.
Originally, Reeves’s March 26 presentation was scheduled to be a quick economic update, but with government bond markets raising anxiety over the £9.9bn fiscal headroom provided by the Chancellor, it is now thought that she may be compelled to announce spending cuts.
“We have requested that the independent Office of Budget Responsibility prepare a forecast, which will be released on March 26. At that time, I will be outlining any necessary adjustments,” Reeves stated.
How Do Government Bond Markets Affect the Cost of Borrowing?
The 10-year yield on government bonds, or gilts, fell to about 4.42% on Wednesday, which is better news for the chancellor. As markets expect lower rates, this is the lowest level since December 16. This decline in yields suggests that borrowing costs may go down, which could alleviate some of the government’s debt.
The Bank of England may drop interest rates by up to six more quarter points in 2025, according to Simon French, chief economist at investment bank Panmure Liberum, despite the fact that the decrease in borrowing costs is welcome. French clarified, though, that the Bank would probably hold off on accelerating cutbacks until political unpredictability subsided.
“We do not believe that the Bank of England will soon shift to a faster rate-cutting strategy in the UK. In our opinion, that will have to wait until the late summer,” he said.
What Position Does the Bank of England Hold Regarding Current Fiscal Policies?
Concerns regarding Reeves’ October budget’s effect on inflation have previously been voiced by the Bank of England. According to several firms, the budget’s increased employment costs may result in higher prices for customers. The Bank is keeping a careful eye on how the budget will affect the overall economy, even with the rate decreases.
After the economic downturn brought on by the Covid epidemic, the MPC hiked interest rates from a low of 0.1% in 2021. High inflation caused rates to peak at 5% in the summer of 2023. The Treasury is hopeful that rate cuts would help increase business and residential loan confidence after economic growth stalled in the second half of last year.
Will Confidence Be Significantly Affected by a Quarter-Point Rate Cut?
Nonetheless, other analysts doubt that a single quarter-point rate drop could result in a notable increase in confidence. “I would be surprised if there is a big boost to confidence on the back of one quarter-point cut,” said Simon Pittaway, senior economist at the Resolution Foundation think tank.
What Future Growth Plans Does Reeves Have?
Reeves has pledged to promote prosperity in face of economic uncertainty by enacting measures like supporting a third runway at Heathrow and lifting obstacles like planning restrictions. While these initiatives may boost growth in the long term, experts believe that the full advantages could take many years to appear.
As the continuous changes in monetary policy continue to influence Reeves’s approach to the budget, her attempts to stimulate the economy come at a time when concerns about fiscal sustainability are at an all-time high. With the Bank of England’s actions and the OBR’s updated predictions potentially influencing government decisions, the coming months will be key in defining the course of the UK’s economic recovery.
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