UK budget dims prospect of aggressive rate cuts, say economists

Hopes for consecutive interest rate cuts by the Bank of England over the next two months have been dampened by the UK government’s recent budget, economists have warned.

These rate cuts typically reduce borrowing costs for consumers and businesses over time.

The likelihood of back-to-back cuts slipped as the market digested last week’s statement, with the probability of a cut in November currently standing at 90%, but 65.2% for another in December, according to Refinitiv data. This is sharply down since last week.

The budget, which expanded fiscal spending by 1.2% of GDP for the coming year, is expected to reduce slack in the economy that might otherwise help lower inflation, according to Pantheon Macroeconomics.

“The positive data flow over the past month that put consecutive rate cuts on the table for the Monetary Policy Committee (MPC) in November and December has been erased by the budget,” Pantheon’s chief economist Robert Wood said.

Markets reacted with hostility to last week’s fiscal statement, with the pound falling sharply and gilt yields – the interest rate paid by the government – rising.

The Office for Budget Responsibility (OBR) forecasts the budget will add 0.5 percentage points to the Consumer Price Index (CPI) in 2025.

Earlier in October, Bank of England governor Andrew Bailey suggested that the MPC could take a more “aggressive” approach to rate cuts if inflation data continued to improve. However, Pantheon economists cautioned that the MPC is now likely to proceed more cautiously, wary of the inflationary impact of the budget’s fiscal loosening.

Pantheon said it now expects the MPC to deliver one more rate cut this year, potentially at this week’s meeting, followed by a 25-basis-point reduction each quarter in 2025, one fewer than previously anticipated.

“All told, we expect one further cut this year, at this week’s meeting,” Pantheon adds. “This is one fewer than we expected at the time of our last forecast review. The market is taking a similar view, with pricing now reflecting a full 25bp less easing by March than before the budget.”

Market expectations have also shifted, now reflecting a full 25 basis points less easing by March than prior to the budget.

The picture is different in the United States, where economists still expect two rate cuts before the end of the year.

Like the MPC, the US Federal Reserve will meet on Thursday, a day later than usual due to Tuesday’s election, and with inflation still cooling, the Fed is expected to reduce interest rates for the second time this year.

Fed policymakers, led by Chair Jerome Powell, are anticipated to lower the benchmark rate by a quarter point, bringing it to around 4.6%, following a half-point cut in September. Economists project another quarter-point reduction in December, with further cuts possibly coming next year.