The Bank of England established the City of London on October 8, 2024 in London, England.
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LONDON — British interest rates may fall faster than previously expected, economists say, pointing to the release of key data that suggests inflationary pressures are finally easing.
However, the Labor government’s first budget, due later this month, will prove crucial as market participants wait to assess its economic impact.
As of Tuesday, money markets had fully priced in a 25 percentage point rate cut at the Bank of England’s next meeting in November, with a similar cut at the December meeting likely.
That would take the central bank’s key interest rate from a 16-year high of 5.25% at the beginning of the year to 4.5% by the end of the year. Pricing suggests a further decline to 4% by the May 2025 meeting and 3.5% by December 2025.
However, Goldman Sachs economists noted in a report on Monday that rate cut expectations were “significantly lower than market pricing.” They attribute this to their calculation of a neutral real interest rate of 0.8% in the second quarter of 2024 (expected inflation of 2% in the economy at full employment), coupled with a rapid decline in UK inflation and the Bank of England Dovish comments from policymakers.
As a result, they expect the bank rate to be cut by 25 basis points in a row to 3% as early as September 2025 and to 2.75% in November next year.
The Bank of England has remained cautious about the path of inflation over the past three years of painful price increases. When its Monetary Policy Committee voted 8-1 to keep interest rates on hold at its meeting on September 19, it said “gradual” easing was still appropriate, especially as services sector inflation Still “high”.
Price growth remains high in the services sector, which contributed 81% to UK economic output in the second quarter of 2024.
But data released last week showed that services inflation fell to 4.9% in September from 5.6%, falling below 5% for the first time since May 2022, which James Smith said was “an important step for the Bank of England.” It could be big news.” Developed Markets Economist at ING.
Services are “somewhat the most important input into the Bank of England’s decision-making process as it attempts to gauge the ‘sustained’ level of inflation in the economy,” Smith said in a note.
Smith added that the Bank of England had forecast interest rates at 5.5% in September, meaning the actual number was “significantly lower than expected”.
Meanwhile, overall UK inflation fell to 1.7% in September from 2.2% in August, below forecasts by economists polled by Reuters and below the Bank of England’s 2% target for the first time in three-and-a-half years.
Inflation has now been close to target for six consecutive months since peaking at 11.1% in November 2022, although more volatility is expected due to the impact on energy markets after price caps set by regulators were raised.
Wage growth data also cooled, with average earnings including bonuses falling to a more than two-year low of 3.8% between June and August.
More broadly, the raging conflict in the Middle East has not sent oil prices soaring, with the International Energy Agency instead saying the oil market will face a “considerable glut” next year. The global inflation situation has calmed down enough, and the Federal Reserve chose to cut interest rates by 0.5 percentage points in September; the European Central Bank announced at its October meeting that the deflation process is “smoothly on track.”
“Recent data has reinforced expectations for another rate cut in November. If the positive news around inflation persists, the Bank of England may even cut rates slightly faster than we currently expect,” David Muir said. Home said in a report last week.
“That said, uncertainty about the economic outlook is high and interest rate expectations will be sensitive to what the government announces in the budget,” Muir added.
Risks still exist
Instead, economists say the UK’s biggest risks are domestic. The Labor government elected in July said its October budget would be a major shakeup aimed at restarting the country’s economy Economic growth is weak.
Prime Minister Keir Starmer warned that the budget would be “painful” for the country as it needs to close what the government says is a 22 billion pound ($29 billion) financing gap left by the previous administration. — Some of its members dispute this figure. Finance minister Rachel Reeves said last month the country would not return to “austerity” but again said tough decisions would need to be made before Labor fully implements the changes it wants to see.
Labour’s message raises considerable uncertainty about how major fiscal consolidation will be achieved, especially as the government has ruled out raising key taxes on income, sales and businesses. It’s unclear what measures will be taken to cut spending or stimulate industry in the future.
Gilles Moëc, chief economist at AXA Group, said the Bank of England should take into account the coming “front-end fiscal consolidation efforts” and accelerate the pace of monetary easing.
“Politically, Keir Starmer can still blame the legacy of the Conservative government for the need for painful fiscal measures – an argument that will soon fade away,” Moeke said in a note on Monday express.
“From an economic perspective, frontloading could persuade the Bank of England to accelerate interest rate cuts, given the immediate suppression of demand, thereby leading to inflation. Given the UK’s strong sensitivity to interest rates and the speed of monetary policy transmission, many of the adverse effects of fiscal tightening are likely to be offset by the currency stance,” he said.
However, expectations are growing that fiscal policy in the budget will be looser than previously expected, Deutsche Bank economist Sanjay Raja said on Monday.
Raja issued new forecasts, predicting that bank interest rates will rise continuously in the coming months, reaching 3.75% by May 2025, and then cut rates every quarter until reaching 3%, but he said that loose fiscal policy may This led to the Bank of England suspending interest rates at 3.75%.
Ruth Gregory, deputy UK chief economist at Capital Economics, said on Friday she expected net fiscal easing to be around £18bn in 2029-2030 relative to previous plans. That’s 0.6% of GDP, as Reeves tries to balance tax increases and increases tax revenues.
“The result will be fiscal policy that is looser than previously planned, but interest rates higher than otherwise planned,” she said.
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