A surprise drop in inflation has lifted pressure off the UK economy, with better-than-expected figures raising expectations for a Bank of England rate cut and reducing borrowing costs.
Unexpected Drop in Inflation Lifts Pressure Off Rachel Reeves
The UK chancellor, Rachel Reeves, has been handed a breathing space after better-than-expected inflation figures raised expectations for a Bank of England rate cut and reduced UK borrowing costs.
The Impact on the Government’s Economic Policy
After a tough week for the government on the economy, official figures showed inflation unexpectedly cooled in December to 2.5%, down from 2.6% in the previous month, meaning prices rose at a slower rate. This development has sent the yield – in effect the interest rate – on UK government bonds tumbling at the fastest rate since 2023.
Economic Outlook and Interest Rate Cuts
With 10-year gilt yields falling by almost 0.2 percentage points to about 4.7%, the sharp decline erased nearly all of the increase of the past seven days, when turmoil in the bond market had forced Reeves to contemplate spending cuts to meet her fiscal rules. Economists say the latest UK snapshot has raised the chances of the Bank of England cutting official interest rates when its policymakers next meet on 6 February.
A More Accelerated Pace of Rate Cuts
In a speech in Leeds, Alan Taylor, a senior Bank policymaker, warned that interest rates could need to be drastically reduced to avoid inflicting lasting damage on households and businesses. He suggested that rates may need to be dropped to as low as 3.25% this year, from a current level of 4.75%, to sustain a soft landing.
Economic Growth and the Government’s Objectives
Official figures are expected to show the economy returned to growth in November after shrinking in October. The Bank has forecast that growth over the entire second half of 2024 is on track to have stagnated. The prospect of deeper interest rate cuts is likely to ease the pressure on the government after a rocky start to the year.
Labour’s Criticism and Reeves’ Response
Labour’s critics had called for Reeves to resign amid accusations that her autumn budget was damaging the economy. However, Chancellor Reeves has sought to restate Labour’s commitment to growing the economy as the primary means of repairing the government finances and fixing battered public services. She stated that she would “continue to go further and faster” to kickstart the economy.
Overseas Investments and Economic Growth
The government has announced a flurry of overseas investments in Britain, including a £4bn project to build 6,500 homes, three schools and an arena on brownfield land in Bristol. Chancellor Reeves is also expected to meet with the heads of the UK’s regulatory bodies into Downing Street on Thursday – including the City and competition watchdogs and Ofgem, Ofwat, and Ofcom – to demand they “get on board” with the government’s objectives by prioritising growth.
Energy Bills and Inflationary Pressures
Despite cooling in December, economists say inflation would still probably increase in coming months, fuelled by rising energy bills. The energy regulator Ofgem’s consumer price cap increased by 1.2% in January, and is forecast to creep higher from April. Business leaders have also warned that Reeves’ planned £25bn increase in employers’ national insurance contributions and 6.7% rise in the minimum wage from April could stoke inflationary pressures.
Sticky Inflation and Central Bank Cuts
Analysts have warned that sticky inflation could derail cuts from the central bank despite stalling economic growth.
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- theguardian.com | Unexpected drop in inflation lifts pressure off Rachel Reeves
