Key Takeaways
- Falling inflation and a lower fiscal deficit allowed the government to announce tax cuts in last week’s Autumn Statement.
- With further tax cuts likely in March 2024, the Bank of England could adopt a more cautious stance to easing monetary policy.
- UK economic data has shown signs of picking up. Energy prices have eased, and real incomes are rising. Rising immigration should help counter wage inflation, however.
- Rate cuts in 2024 still seem likely but the UK now looks set to lag the US and Europe in reducing borrowing costs.
Last week’s Autumn Statement was widely welcomed here in the UK as it partially relieved the upward trend in taxes. It followed the latest data which showed a lower fiscal deficit and a fall in UK inflation that was both big and bigger than expected.
Nonetheless, I am now delaying my forecast for base rates cuts next year. I have been arguing for some time that rate cuts in 2024 will come sooner and be bigger than many expect in UK and elsewhere. I still think that’s true for Europe and the US, but I now expect the UK to join the rate-cutting party late.
There are two main reasons for this. First, having seen the government use every penny (and a bit more) of the headroom under their fiscal rules to cut taxes, the members of the Bank of England’s rate-setting committee will no doubt suspect that they will do so again in the budget next March. In addition, the government has announced a 10% rise in the minimum wage next April and reduced the age for the full amount to 21 from 23. I had expected a much lower number. As the minimum wage rises relative to other wages it affects more and more people. 2.7 million will benefit this time around. That is to be welcomed from a social perspective, but it will diminish and delay the slowdown in overall wage inflation.
Second there are signs of a pickup in UK economic activity. Energy prices are over 20% below last year, real incomes are rising, as wages move ahead of prices and winter fuel allowance are paid to those on social security. The latest data show a rise in the purchasing managers’ indices, a rise in employment and a rise in consumer confidence. I reckon retail sales are likely be strong in the run up to Christmas.
It’s not all bad news for inflation and interest rates. Oil prices are falling, and distillate prices are weaker still. Sterling strength will help more broadly and the prices of goods at the ports are already falling and wholesale food price inflation has tumbled. I had expected rising immigration to help slow wage inflation. The latest figures show net migration is running at record levels over the last couple of years, much higher than previously thought. Yet wage inflation remains high here in the UK, much higher than in the US and Europe.
The ups and downs of UK interest rates
Source: Columbia Threadneedle Investments, Bloomberg and Macrood as at 24/11/2023
This chart plots the 5-year swap rates for the UK. The numbers reflect the market’s expectations for interest rates over the next 5 years. The reaction to last week’s unexpected fiscal easing was nothing like as severe as post the Liz Truss/ Kwasi Kwarteng mini budget. But that followed a big rise in interest rates overseas, notably in the US. It also reflected the radical rejection of fiscal orthodoxy and surging UK inflation at the time. This time around the government has benefited from falling inflation and falling overseas interest rates. They also allowed the Office for Budget Responsibility to check the numbers, albeit with totally implausible assumptions for public spending cuts. The market reaction so far has been modest.
The Bank of England has kept base rates on hold since August but there have been three dissenters who voted for an increase. It would only need two others to join them for base rates to be increased again. That’s not my central scenario but it’s a risk that has become more likely over the last week.
I still think we will get big cuts in interest rates in 2024. The near-term outlook will be dominated by US employment figures, out early next month. I do expect rising unemployment in the UK eventually to reduce wage inflation despite the minimum wage increase. This year’s sterling strength contrast with last year’s weakness is another favourable factor but rates cuts early next year now seem unlikely.
