The Bank of England has announced its rate cut of 0.25 percentage points, reducing the base rate from 5 per cent to 4.75 per cent. The decision, voted 8-1 by the Monetary Policy Committee, is the second rate cut to be announced by Threadneedle Street since the inflation crisis began.
Markets were expecting a rate cut today, after the Bank held rates in September. The BoE has been clear that bringing down the base rate will be a slow and steady process, as the Committee continues to assess the impact of lower rates on the economy and potential inflationary effects. This ‘gradual approach’ was reconfirmed today in the MPC’s minutes, as inflation is expected to rise slightly above target by the end of the year, to around 2.5 per cent.
Still, it was not certain that there would be a cut. Market response to Rachel Reeves’s first Budget – and plans to increase borrowing – has not been smooth and UK borrowing costs are currently higher than they were ahead of the Budget.
It’s worth noting how current borrowing costs compare to what was forecast by the Office for Budget Responsibility alongside the Budget last week. The OBR estimated that the Budget would keep both rates and gilt yields 0.25 percentage points higher across its forecast compared to the March Budget. Yet since the Budget, five-year gilt yields have risen to 4.3 per cent – more than half a percentage point higher than the OBR’s forecast. If that forecast turns out to be wrong over the medium-term, and investors conclude that they need a greater return when lending to Britain, Reeves looks set to lose a lot of fiscal headroom. The Chancellor could end up having to pay billions more in debt servicing costs – just to pay for money borrowed.
Still, today’s rate cut and report is good news for the government overall, which has been facing warnings that unsteady reactions to the Budget could mean rates remain higher for longer than previously anticipated. It’s still possible the reaction to the Budget will slow rate cuts over a longer period of time, especially if gilt yields don’t show signs of reducing or if inflation meaningfully ramps up again: the Bank also notes that decisions made in the Budget, including the ‘rise in the cap on single bus fares from £2 to £3 and the introduction of VAT on private school fees from January, and the increase in Vehicle Excise Duty from April’ will all contribute to an uptick in inflation from the start of next year – and the Bank has revised its forecast for inflation in the fourth quarter up from 2.2 per cent to 2.7 per cent.
But for a Bank that was reported to be on ‘high alert’ after the Budget, its first round of assessments seems to be that the situation is calm (enough) to push forward with a rate reduction. That’s a good indication to the markets, and a sigh of relief for Labour.
Of course, many economic factors remain out of the government’s control, including elections overseas. There are outstanding questions about the true intentions behind President-elect Donald Trump’s economic agenda – currently including drastic tariffs – which could run the risk of derailing the Bank’s plans to keep reducing the rate. Of course, there are plenty of reasons to be sceptical that Trump will really push ahead with 20 per cent tariffs on imported goods (not least because of the pain it would cause American consumers). Regardless, the Bank will be watching like a hawk.
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