Bank of England may cut rates despite risk of inflation rise

The Bank of England is widely expected to reduce interest rates in the wake of reports predicting that the Labour Party’s recent Budget could fuel higher inflation over the next year. A statement will be made public this Thursday following their November meeting, and market experts are largely forecasting a quarter-point decrease in the base rate from 5% to 4.75%.

Last month brought a sense of optimism as the headline rate of inflation fell to a modest 1.7%—the lowest since April 2021—and services sector inflation also dropped, bolstering the belief that policymakers will choose to lower the rate. The aim is to manage borrowing costs and directly impact mortgage rates.

Meanwhile, wage growth appears to have slowed, reaching its least aggressive pace in two years, with data revealing a deceleration to 4.9% over the three months leading up to July. Economist Thomas Pugh from consultancy firm RSM cites both the reduced inflation figures and wage growth slowdown as strong indications that an interest rate cut is "nailed on".

These financial manoeuvres arrive just one week after Chancellor Rachel Reeves disclosed nearly £70 billion in additional yearly spending, underpinned by increased taxes on businesses and further government borrowing. While the Office for Budget Responsibility (OBR) has suggested that the substantial escalation in expenditure may bring about greater inflation, it acknowledges that it could simultaneously give rise to enhanced economic growth.

The Office for Budget Responsibility (OBR) has forecast that inflation will average 2.5% this year and 2.6% next year before it starts to decrease, provided "the Bank of England responds" to help steer it towards the target rate. This outlook has led economists to scale back their expectations for a swift series of interest rate reductions over the coming year.

Mr Pugh commented that following the fiscal expansion in the Budget, interest rates are "likely to fall more slowly over the course of the next year. Indeed, a sequential rate cut in December now looks unlikely."

The markets have adjusted their predictions to fewer than four quarter-point cuts from the Bank by the end of next year, a reduction from just under five anticipated prior to the Budget. Matt Swannell, chief economic adviser to the EY Item Club, mentioned that he doesn't believe the Budget will "prevent future interest rate cuts".

He added: "At its November meeting, the MPC will probably continue to indicate that it is more confident inflation persistence is easing, but that Bank Rate will have to remain restrictive for some time and that future rate cuts will likely be gradual."