‘Lingering’ inflation warning as UK secures major economic upgrade
The UK remains at risk from “lingering” inflation but its economy is among nations showing “robust” growth, according to a biannual report which upgrades its expectations for output both this year and next.
The Organisation for Economic Co-operation and Development (OECD) saw UK gross domestic product (GDP) rising by 1.1% this year – faster than the euro area combined.
That compared to a figure of just 0.4% it had forecast for 2024 back in May.
It marked one of the biggest upgrades to forecasts among the Paris-based club’s 38 member states.
Its predictions, the OECD cautioned, continued to be at the mercy of world events following a succession of shocks in recent years from COVID, Russia’s invasion of Ukraine and the conflict in the Middle East.
The UK upgrade largely reflected the better-than-expected performance seen during the first six months of the year when the country exited the recession of the second half of 2023.
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The downturn was widely blamed by economists on the impact of Bank of England interest rate hikes to bring down inflation.
In its update, the OECD said a high pace of wage growth, while moderating, remained a threat to the UK inflation outlook.
It also pointed to continued pressure from services price inflation.
The findings chimed with recent commentary from the Bank of England that it would take a cautious approach to further interest rate cuts, following the shift to 5% from 5.25% seen in August.
The OECD suggested UK growth would accelerate mildly to 1.2% during 2025 – a timeframe ahead that is currently shrouded in mystery as the new Labour government is yet to outline its first budget, due on 30 October.
Chancellor Rachel Reeves has promised a focus on bolstering growth.
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She said of the report’s findings: “Faster economic growth figures are welcomed, but I know there is more to do and that is why economic growth is the number one mission of this government.
“Next month’s budget will be about fixing the foundations, so we can deliver on the promise of change and rebuild Britain.”
The OECD forecasts showed a further downgrade for Europe’s largest economy, Germany, which was seen as growing by only 0.1% this year.
Its anticipated performance, largely a consequence of an uncompetitive manufacturing base during a time of slowdown in China, has proved a drag on the wider euro area’s GDP forecast.
That stood at an unrevised 0.7%.
The European Central Bank is expected to act twice more this year to cut borrowing costs in a bid to bolster flagging activity.
Its US counterpart cut its target range for the first time since 2020 last week amid worries over a hiring downturn.
The OECD said it still expected US GDP growth to slow to a rate of 2.6% this year – cushioned by further monetary policy easing as inflation came under control.
The report predicts: “Significant risks remain. Persisting geopolitical and trade tensions could increasingly damage investment and raise import prices.
“Growth could slow more sharply than expected as labour markets cool, and deviations from the expected smooth disinflation path could trigger disruptions in financial markets.
“On the upside, the recovery in real incomes could provide a stronger boost to consumer confidence and spending, and further oil price declines would hasten disinflation.”
It added: “Decisive fiscal actions are needed to ensure debt sustainability, preserve room for governments to react to future shocks and generate resources to help meet future spending pressures. Stronger efforts to contain spending and enhance revenues, set within credible medium-term adjustment paths, are key to ensuring that debt burdens stabilise.”
The business secretary will next week hold talks with dozens of private sector bosses as the government contends with a significant corporate backlash to Labour’s first fiscal event in nearly 15 years.
Sky News has learnt that executives have been invited to join a conference call on Monday with Jonathan Reynolds, in what will represent his first meaningful engagement with employers since Wednesday’s budget statement.
Rachel Reeves, the chancellor, unsettled financial markets with plans for billions of pounds in extra borrowing, and unnerved business leaders by saying she would raise an additional £25bn annually by hiking their national insurance contributions.
An increase in employer NICs had been trailed by officials in advance of the budget, but the lowering of the threshold to just £5,000 has triggered forecasts of a wave of redundancies and even insolvencies across labour-intensive industries.
Sectors such as retail and hospitality, which employ substantial numbers of part-time workers, have been particularly vocal in their condemnation of the move.
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On Friday, the Financial Times published comments made by the chief executive of Barclays in which he defended Ms Reeves.
“I think they’ve done an admirable job of balancing spending, borrowing and taxation in order to drive the fundamental objective of growth,” CS Venkatakrishnan said.
His was a rare voice among prominent business figures in backing the chancellor, however, with many questioning whether the government had a meaningful plan to grow the economy.
Mr Reynolds held a similar call with business leaders within days of general election victory, and over 100 bosses are understood to have been invited to Monday’s discussion.
A spokesman for the Department for Business and Trade declined to comment ahead of Monday’s call.
First things first: don’t panic.
What you need to know is this. The budget has not gone down well in financial markets. Indeed, it’s gone down about as badly as any budget in recent years, save for Liz Truss’s mini-budget.
The pound is weaker. Government bond yields (essentially, the interest rate the exchequer pays on its debt) have gone up.
That’s precisely the opposite market reaction to the one chancellors like to see after they commend their fiscal statements to the house.
In hindsight, perhaps we shouldn’t be surprised.
After all, the new government just committed itself to considerably more borrowing than its predecessors – about £140bn more borrowing in the coming years. And that money has to be borrowed from someone – namely, financial markets.
But those financial markets are now reassessing how keen they are to lend to the UK.
The upshot is that the pound has fallen quite sharply (the biggest two-day fall in trade-weighted sterling in 18 months) and gilt yields – the interest rate paid by the government – have risen quite sharply.
This was all beginning to crystallise shortly after the budget speech, with yields beginning to rise and the pound beginning to weaken, the moment investors and economists got their hands on the budget documentation.
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Chancellor challenged over gilt yield spike
But the falls in the pound and the rises in the bond yields accelerated today.
This is not, to be absolutely clear, the kind of response any chancellor wants to see after a budget – let alone their first budget in office.
Indeed, I can’t remember another budget which saw as hostile a market response as this one in many years – save for one.
That exception is, of course, the Liz Truss/Kwasi Kwarteng mini-budget of 2022. And here is where you’ll find the silver lining for Keir Starmer and Rachel Reeves.
The rises in gilt yields and falls in sterling in recent hours and days are still far shy of what took place in the run up and aftermath of the mini-budget. This does not yet feel like a crisis moment for UK markets.
But nor is it anything like good news for the government. In fact, it’s pretty awful. Because higher borrowing rates for UK debt mean it (well, us) will end up paying considerably more to service our debt in the coming years.
Rachel Reeves leaving 11 Downing Street before the budget. Pic: PA
And that debt is about to balloon dramatically because of the plans laid down by the chancellor this week.
And this is where things get particularly sticky for Ms Reeves.
In that budget documentation, the Office for Budget Responsibility said the chancellor could afford to see those gilt yields rise by about 1.3 percentage points, but then when they exceeded this level, the so-called “headroom” she had against her fiscal rules would evaporate.
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In other words, she’d break those rules – which, recall, are considerably less strict than the ones she inherited from Jeremy Hunt.
Which raises the question: where are those gilt yields right now? How close are they to the danger zone where the chancellor ends up breaking her rules?
Short answer: worryingly close. Because, right now, the yield on five-year government debt (which is the maturity the OBR focuses on most) is more than halfway towards that danger zone – only 56 basis points away from hitting the point where debt interest costs eat up any leeway the chancellor has to avoid breaking her rules.
Now, we are not in crisis territory yet. Nor can every move in currencies and bonds be attributed to this budget.
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Markets are volatile right now. There’s lots going on: a US election next week and a Bank of England decision on interest rates next week.
The chancellor could get lucky. Gilt yields could settle in the coming days. But, right now, the UK, with its high level of public and private debt, with its new government which has just pledged to borrow many billions more in the coming years, is being closely scrutinised by the “bond vigilantes”.
A Halloween nightmare for any chancellor.
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