Spring interest rate cut back on the cards as economy stutters

Expectations of interest rate cuts in the spring have resurfaced after a series of economic data forced a rethink of the outlook for UK monetary policy.

Britain was confirmed to have fallen into a technical recession at the end of last year, with GDP contracting 0.3 per cent in the fourth quarter, following data from earlier in the week showing lower-than-expected inflation and slight relaxation of the work situation. market.

But while the latest figures point to a mild recession, the data also highlights the impact of economic stagnation suffered by Britons, with GDP per capita lower than global peers, putting pressure on the Government ahead of the budget. of spring.

Government bond yields fell on Thursday morning, with five- and 10-year bonds below 4 per cent, as traders raised bets on the scale of the Bank of England’s base rate cuts forecast for this year.

Market prices now suggest the Bank of England could cut the base rate from its current level of 5.25 percent to 4.5 percent by the end of this year.

Traders are divided on the prospect of a 25 basis point (bp) cut to 5 percent at the bank’s March meeting, but have fully priced in such a move for June.

At its last meeting, the bank’s Monetary Policy Committee opted to keep rates unchanged, with two members even voting in favor of an increase.

Thomas Pugh, British economist at RSM UK, said confirmation of a recession “gives the Bank of England more cover to pivot towards lowering interest rates as early as spring.”

The bank has previously rejected expectations of a spring rate cut, with policymakers particularly concerned about services inflation and persistent wage growth.

However, this week’s data could force the Bank of England to act.

Pugh said: ‘The economy will remain stagnant for the first half of this year, but by summer inflation should return to around 2 per cent, interest rates will likely fall and consumers could enjoy significant tax cuts.

“This will kick-start a consumer spending-driven recovery that should allow the economy to finally return to growth.”

‘Overall, today’s data reinforces our view that the fourth quarter of last year will represent the nadir of a particularly painful period of stagnation for the UK economy.

‘But now we are at a turning point. Interest rate cuts are likely to come in the spring and growth should gradually improve in the first half of this year and recover further after the summer and into 2025.’

But James Sproule, chief economist at Handelsbanken, expects the Bank of England to take longer to cut rates and for Britain to experience a weaker economic recovery.

He said: ‘The political scoring in an election year will be considerable.

‘Our forecast remains that we will see a very gradual recovery (quarterly below 0.5 percent) over the course of 2024, helped by slow real wage increases, a fall in inflation, potential tax cuts in March and beyond. mid-year, our expectation of a slow reduction in interest rates.’

Pressure on government to address impact on consumers and businesses

The ONS data also revealed the impact of stagnation at an individual level, with GDP per capita falling 0.7 per cent for the year as a whole and four consecutive quarters of decline.

GDP per capita remains 1.1 percent below pre-Covid levels in the third quarter of 2019. By contrast, GDP per capita is 6 percent higher in the United States over the same period and 2.7 percent in the European Union.

Panmure chief economist and head of research Gordon Simon French noted that the UK has recorded just 0.7 per cent GDP per capita growth over the past 20 years, “70 per cent less than the rate of the previous four decades”.

“On the contrary, GDP growth has halved,” he added.

And while wages continue to rise, separate data from the Resolution Foundation shows household incomes are not expected to reach their pre-cost of living crisis peak until 2027 “at the earliest” amid higher taxes and pressures of costs.

Weak real wage growth has been a problem in Britain since the 2008 financial crisis, which marked the start of long-term stagnation.

“The cumulative effect of 15 wasted years is enormous: £10,700 per worker per year (or £205 per week) compared to a world in which wages had continued to grow at pre-financial crisis rates,” according to the group. experts.

Sian Steele, head of tax at Evelyn Partners, said: “The Government could pass an autumn statement before the election, but the feeling is that if the aim is to make UK households feel better and more optimistic, then spring The budget is the time to act.

‘It looks like a new National Insurance cut is emerging as the favorite for a big tax announcement in the Budget. This would allow the Government to re-present the tax cut as focused on encouraging work, rather than as an income tax measure that would benefit a broader section of the population, including pensioners.

British businesses of all sizes are also keen to see action taken in the March Budget, with the economic crisis during the second half of last year being particularly acute in the services, manufacturing and construction sectors, according to the ONS.

Federation of Small Businesses national president Martin McTague said: ‘Small businesses are dealing with high interest rates, much higher energy costs than a couple of years ago and weak consumer demand.

‘Two in five small businesses said their revenue decreased during the final quarter of last year, and only a third said it increased, showing that the shine has definitely taken off from the so-called ‘golden room’, to the detriment of small businesses. .

“The Government needs to foster an environment where small businesses can grow, to the overall benefit of the economy, and put this period of stagnation and contraction behind us once and for all.”

Roger Barker, policy director at the Institute of Directors, added: ‘Business leaders will now turn their attention to the future.

‘Recent data from our members suggests that business confidence has improved slightly in recent weeks. It is important that this progress is underpinned by the political decisions of the Chancellor and the Bank of England.’