MNI POLICY: Budget To Push Up BOE Growth, Inflation Forecasts
MNI (LONDON) - The Bank of England looks set to factor in elements of the new Labour government's Oct 30 Budget into its projections out on Nov 7, with fiscal easing substantially pushing up the outlook for near-term growth and inflation.
While the tight timeframe will make it challenging for Bank staff to work the budget’s detail into its central projection in its Monetary Policy Report, the broad fiscal thrust could be incorporated more easily into an accompanying economic scenario, which is not so fleshed out.
Bank staff have previously reacted quickly to incorporate changing fiscal assumptions into a Monetary Policy Report. In 2021 the Autumn Budget and spending review details were published on Oct 27 and were included in the central projection of the BOE's MPR on Nov 4.
Market bets on a near-certain 25 basis-point rate reduction in November have survived the Budget, but the perceived probability of another such cut in December has subsided, with the fiscal arithmetic likely to strengthen the case for more gradual easing. The yield on 10-year gilts has risen by around 20 basis points since Chancellor of the Exchequer Rachel Reeves delivered her spending and tax plans.
In its fiscal arithmetic accompanying the Budget, the Office for Budget Responsibility added 25bp to its assumptions for Bank Rate and gilt yields, which were based on market pricing until Sept 12, assuming that the BOE would now only be able to cut Bank Rate to 3.5% by the end of its forecast period. (See MNI INTERVIEW: UK Budget Ups Inflation Pressure - OBR Miles)
NO MORE SPENDING SQUEEZE
Given that the BOE’s previous set of projections in August assumed a spending squeeze planned by the former Conservative government, which lost elections in July, the effect on this month’s round could be substantial, though the impact on the policy views of the different members of the Monetary Policy Committee will be less pronounced. Convention meant that the BOE had to base its assumptions on the most recent government fiscal outline until it was officially updated.
Independent MPC member Catherine Mann said at a recent 'Reinventing Bretton Woods' event in Washington that "(the) August, Monetary Policy report identified the then announced fiscal policy by the previous administration as being a significant drag on economic activity, an opening up of the output gap, a rising unemployment rate and therefore a deceleration in inflation." (See MNI INTERVIEW: UK Budget Investment Spending To Curb Rate Cuts)
As Bank staff absorb the Budget in more detail beyond this week’s MPC meeting, key questions will also include the likely response of consumers to its mix of tax hikes, a rise in the minimum wage and higher investment spending. This will have implications for the household savings ratio, whose recent rise has been in the monetary policy spotlight, with MPC members including Megan Greene, Swathi Dhingra and Mann expressing uncertainty over whether it can be sustained.
Mann, previously the most hawkish of MPC members, said she was particularly interested in middle earners, who are most flexible in adjusting consumption and have been subject to tax creep, and that she was revisiting her view that the higher saving ratio was "dry powder" for consumption.