Keir Starmer said Thursday’s quarter-point rate cut from the Bank of England would be welcomed by many voters who would see “more money in their pockets”. The prime minister is right, at least when it comes to borrowers on floating-rate mortgages, and Labour will be glad the nine-member monetary policy committee (MPC) has signalled clearly it is in cutting mode.
The Bank’s governor, Andrew Bailey, said the MPC would be “taking a gradual and careful approach to reducing rates further” – and the fact that two of the MPC’s nine members wanted a larger, half-point cut signals more to come.
Lower borrowing costs can feed through fairly rapidly to firms and households, compared with the impact from the runways, power stations and bridges that form the heart of Rachel Reeves’s “plan for growth”. And against the right economic backdrop, rate cuts can act as a short-term mood-booster.
Yet the reason policymakers felt free to push the button on the third rate cut since last summer was that the outlook for economic growth is so gloomy. The picture painted by the Bank’s quarterly inflation report, published alongside the rate decision, is unambiguously bleak.
The MPC has halved its forecast for GDP growth in 2025, from the 1.5% it was predicting in November to a sickly 0.75%. Economic output is expected to have contracted by 0.1% in the final three months of 2024 and expanded by just 0.1% in the current three-month period – narrowly skirting a recession, defined as two successive quarters of decline. The Bank suggests productivity, which Reeves badly wants to improve, has declined.
If the independent Office for Budget Responsibility (OBR) takes a similar view, it could make a sharp downgrade to its growth forecasts when these are published on 26 March, from the 1.9% it was predicting in October.
Whether that wipes out Reeves’s room for manoeuvre against her fiscal rules depends on how the OBR assesses the longer-term outlook. Market expectations of lower rates in the UK may bear down on the government’s cost of borrowing, helping to offset some of the impact on the public finances from weaker growth.
But the MPC’s gloomy prognosis sits in stark contrast to Reeves’s determinedly upbeat messaging on growth in recent weeks, including in last week’s speech.
With her pledge to sweep away obstacles to investment, Reeves is battling to repair business and consumer confidence, after spending much of the government’s first six months in power pointing to the Tories’ parlous economic legacy.
The MPC does not expect the economy to begin bouncing back until later in 2025, and Bailey stressed it had not even factored in the potential downsides of Donald Trump’s trade tariffs, which are still regarded as too uncertain to compute.
Even as economic growth bumps along the bottom, though, the Bank expects inflation to come surging back, driven by rising global energy prices and aided by increases in water bills and bus fares.
By the end of the summer, the Bank is forecasting inflation of 3.7%, well short of the 11% peak after the Covid pandemic and Russia’s invasion of Ukraine, but significantly above the Bank’s 2% target.
This uncomfortable combination of weak growth and higher prices will inevitably lead to claims that the UK is sliding towards “stagflation”, though Bailey insisted he didn’t use the word.
So what is the reason the Bank’s policymakers feel able to cut rates, despite this jump in the pace of price rises? They believe the jobs market has now weakened so much that workers will be unable to bid up their pay to compensate, creating the kind of wage-price spiral that central bankers dread.
The MPC reckons post-tax incomes – one measure of living standards – will rise by a measly 1.25% in inflation-adjusted terms in 2025, and then by just 0.25% in each of the next two years.
For a government hoping to restore economic growth in a way that voters can see on their streets and feel in their pockets, the Bank’s forecasts suggest a very rocky period ahead.
