With last week’s budget giving wealth managers – as well as the members of the BoE’s MPC – much to consider, Jumana Saleheen, Chief Economist & Head of Investment Strategy Group at Vanguard Europe, has shared her outlook with us ahead of this week’s interest rate announcement on Thursday, explaining why she thinks the Bank will decide to cut by 0.25% to 4.75%.
In terms of the bottom line, Saleheen said: “The new Labour government’s budget was a net fiscal loosening, despite the headlines of substantial tax rises. A lot of the spending will be front-loaded, and this will boost demand and inflation in 2025. However, the recent spot data has been encouraging, with services inflation in particular running significantly below the Bank’s August projections. As such, we expect the MPC to cut Bank Rate on Thursday by another 0.25%, leaving it at 4.75%. However, given the fiscal stimulus down the track, we remove one rate cut from our forecast over the next 12 months. Expect the December meeting to be a hold and for Bank Rate to end 2025 at 3.75% (vs 3.5% previously).”
But she goes on to explain some of the detail behind that bottom line picture as follows: “It’s a big week. US elections, China’s NPC meeting, the Fed. But don’t forget the little old Bank of England…
“Analysing the impact of last week’s budget will be top-of-mind for the monetary policy committee (MPC) this week. Despite the headline of taxes increasing by £40bn, the Budget represented a large fiscal expansion. Spending will increase by almost £70bn over the next five years (2% of GDP), split two-thirds on current spending and one-third on investment. The size of the state is set to become structurally larger too, with both government spending and taxation to increase by five percentage points of GDP by the end of the decade.
“The UK’s fiscal watchdog – the Office of Budget Responsibility (OBR) – estimates the budget will increase demand by 0.6% in 2025/26, with a large chunk of spending front-loaded and tax multipliers small. We think this is an underestimate – the assumptions on the revenue raised via increased employer national insurance contributions are too optimistic, given the expected negative effects on employment and wages. As such, we expect a loosening closer to 0.8% of GDP in 2025 and upgrade our core inflation forecast by 0.3 percentage points too. Our modelling suggests this justifies removing around 25 basis points from the projected rate easing path over the next 12 months.
“However, the hawkish signal from the Budget should also be countered by the dovish news on the spot wage and inflation data. Both growth in private sector regular pay, and services inflation, have decelerated in recent months and now stand significantly below the Bank of England’s August projections. This paves the way for the MPC to continue its easing cycle at a quarterly cadence. Expect Bank Rate to be cut by 0.25% at the November meeting with an 8-1 majority (Catherine Mann is likely to dissent). We now expect the MPC hold in December, absent a significant further downside surprise in the inflation data in the coming two months. As such, we upgrade our end-25 Bank Rate call to 3.75%, from 3.5% previously.”
