The Bank just outed itself as Hunt’s worst enemy

Threadneedle Street has not given the Chancellor cause for optimism. Will the OBR follow its lead?

The Old Lady of Threadneedle Street was in no mood to hand Jeremy Hunt a pre-budget boost yesterday. The Chancellor, who took the unusual step in December of talking up the prospect of rate cuts, was left disappointed as Bank of England Governor Andrew Bailey said it was too early to declare victory against inflation.

The Bank’s first interest rate decision of the year saw policymakers keep rates on hold at 5.25pc in the first three-way split on whether rates should rise or fall since the 2008 financial crisis.

While inflation is expected to temporarily halve from 4pc in December to the Bank’s 2pc target this spring, Bailey highlighted that pay growth remained too high, inflation was still stubborn and “significant risks” to the global outlook remained.

In Bailey’s own words: “We have come a long way. That is good news. But we are not there yet.”

Less than five weeks before Hunt delivers his second Budget, the Bank’s forecasts revealed just how powerful its single lever of interest rates has on growth, inflation and jobs.

Keeping rates higher for longer means households and businesses face more pain. The forecasts also illustrate how difficult it will be to navigate the path to a soft landing.

It said following market predictions of interest rates falling to around 4.25pc by the end of this year and 3.2pc by the end of 2026 meant inflation was likely to remain stubbornly high.

By contrast, keeping them at 5.25pc for the next three years risked condemning the UK to a two-year recession. The Bank signalled that its actions were likely to fall somewhere in between. Bailey himself played down the significance of the latter scenario, saying it assumed a world where rates remained at 5.25pc “forever” – and all the wild movements in asset prices that would go with it. But it also highlighted how crucial the Bank’s outlook for the economy is for Hunt. After all, lower borrowing costs will significantly reduce the Government’s debt interest bill.

When that bill amounts to £100bn every year, getting borrowing costs down matters. The economy is expected to avoid falling into recession, while households are likely to see a big drop in typical energy bills this April from £1,928 a year to £1,620.

This drop is expected to push inflation down rapidly, falling to 3.5pc in February and 3.1pc in March. The Bank believes it will then average 2pc in the second quarter of 2024 – exactly the Bank’s target. Threadneedle Street also declared that the UK was past peak pain from mortgage rates. More than half of the 9m families with a mortgage had now been hit by higher costs after renewing their fixed-rate deals. A further 2.3m may remortgage this year.

Mortgage rates have fallen sharply in recent months amid expectations that the Bank will start cutting rates this summer. The Bank also suggested there was evidence that house prices had bottomed out.

James Smith at the Resolution Foundation said many of these borrowers will now see “smaller cost rises than they might have feared, while lower prices will be a relief to everyone”. Previous Bank research showed that many households had coped well with higher borrowing costs. Around half of those surveyed last autumn said they were planning to take no action at all in anticipation of higher mortgage rates.

Households with fixed-rate mortgages expiring this year were more likely to take action, with many borrowers responding to an expected £100 increase in monthly mortgage payments by cutting their average spending by £28 over the past year. Families said they were expecting to “expand this reduction to £37 per month in the next year”.

There are also signs the rental market is stabilising. The Bank also said many landlords had given up trying to sell their properties, which was helping rents to stabilise.

Some buy-to-let landlords are now struggling to sell and so are re-letting properties, it said. However, while the days of double-digit inflation are behind us, the Bank expects prices to start rising more quickly again in the second half of the year, with inflation hitting 2.8pc in the start of 2025.

This suggests that Threadneedle Street believes markets are getting ahead of themselves on rate cuts.

Hunt has also himself to blame for stoking inflation after increasing the minimum wage by almost 10pc.

The Bank also said his decision to reduce national insurance would push up prices. A Bank survey showed business cited the increase in the national living wage (NLW) to £11.44 from April as the biggest factor affecting pay settlements this year.

This alone was likely to push up pay growth by “around 0.3 percentage points”. Lowering the age at which workers are covered by the main NLW rate from 23 to 21 years would also keep inflation higher for longer. Around 5pc of all workers are currently paid the minimum wage.

“Looking ahead, retailers cite the increase to the NLW, changes to business rates, and potential supply shocks such as the Red Sea disruption, as upside risks to inflation,” the Bank said. Smith said: “With lower price pressures partly being driven by lower wage growth, workers are unlikely to see the fruits of lower inflation in their pay packets. In fact, real wages are forecast to £400 a year lower by 2026. The route to stronger wage growth will instead have to come from the hard yards of higher productivity.”

The Bank has one of the most pessimistic views on productivity in the City, which means it believes the UK has little room to grow before inflation starts to become a problem. Hunt himself acknowledged this week that “major structural weakness” in the economy would limit his scope to cut taxes. The Office for Budget Responsibility will deliver its own judgment of the speed limit of the UK economy in March.

The tax and spending watchdog has been much more optimistic about productivity than the Bank, though any downgrade could throw Hunt’s plans for big tax cuts out the window.

Laith Khalaf, head of investment analysis at AJ Bell, noted that while the Bank upgraded its growth forecasts from zero to 0.25pc this year and 0.75pc in 2025 instead of 0.25pc, there remained “little cause to cheer the upgrade”. He added: “Back in November, the OBR predicted growth that would come in at 0.7pc for 2024 and 1.2pc for 2025, while the latest forecasts from the IMF suggest growth of 0.6pc in 2024 and 1.6pc in 2025.

“The dismal nature of the science of economics means it’s impossible to tell who will be right, but significantly no one is predicting barnstorming growth this side of an election.”

‘Borrowers will now see smaller cost rises than they might have feared’ ‘With lower price pressures partly being driven by lower wage growth, workers are unlikely to see the fruits of lower inflation in their pay packets’