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The Bank of England is expected to cut the base rate this week in a boost to borrowers, however hopes of a second cut before Christmas are fading.
An increase in taxes in the Budget is expected to feed through to higher inflation in the coming months and years, which has brought predictions that the Bank will be forced to keep interest rates higher than previous expected.
The Bank’s nine-strong Monetary Policy Committee (MPC), which sets interest rates, is forecast to cut the base rate by a quarter of a percentage point to 4.75 percent on Thursday.
The MPC will also publish its latest inflation and growth forecasts, providing the first indication of whether the Bank thinks Labour’s tax and spending plans could raise short-run inflation and stimulate growth.
Investors have pared back their expectations for two rate cuts before the end of the year after Rachel Reeves announced a £70 billion a year spending plan, carried out through £40 billion in tax rises and £30 billion in extra borrowing.
Matt Swannell, chief economic adviser to the EY Item Club, a forecaster, said the budget announcement would not “derail a cut in bank rate at November’s MPC meeting”.
He added: ““At its September meeting, the Bank of England’s guidance set the stage for another reduction in Bank Rate.
“Since then, key barometers of inflation’s stickiness — services inflation and pay growth — have continued to fall back more quickly than the MPC had previously forecast. On balance, these positive developments should give most of the MPC the confidence to dial back Bank Rate a little further,” Swannell said.
The Office for Budget Responsibility, the government’s fiscal watchdog, said Labour’s policies would raise average inflation by 0.6 percentage points above previous forecasts next year and inflation would only sustainably fall to the Bank’s 2 percent target in 2029.
It now expects the Bank of England base rate to fall from its current figure of 5 percent to 3.5 percent by 2029, which is around 0.5 percentage points higher than its March forecast and 0.25 percentage points higher than before the Budget.
The OBR also forecast that the average mortgage rate would rise from 3.7 percent in 2024 to 4.5 percent in 2027. The average rate on a five-year fix on Thursday was 5.09 percent, while a two-year fix was 5.39 percent.
Ales Koutny, head of international rates at Vanguard, the world’s second largest asset manager, said there is a chance the Bank of England may not cut rates this week if, in its view, the Budget will lead to higher inflation.
He told Bloomberg TV: “The markets still view a cut from the BoE next week as a given. I see it more as 50-50.”
Analysts at Nomura, a Japanese bank, said that the undershoots in inflation in recent months would lead the MPC to downgrade its inflation and growth outlooks this year. “Further ahead, we don’t expect a material revision to [the Bank’s] view on the end horizon point for either inflation or growth,” they said.