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Rishi Sunak’s hopes of contesting the general election on the back of lower taxes and cheaper mortgages took a hit on Thursday as traders scaled back expectations for interest rate cuts in 2024.
Conservative officials have admitted that unexpectedly high inflation data recorded in the US on Wednesday is “worrying” and could have a knock-on effect on the UK economy and the party’s election strategy.
Investors are now betting on just two quarter-point rate cuts from the Bank of England this year, compared with expectations in January of at least six over the course of 2024 and around three in March, when Chancellor Jeremy Hunt presented his budget.
This poses a potential problem for Hunt and Sunak, who had hoped the BoE would start cutting interest rates well before the general election, widely expected in the autumn.
“That will probably be the moment when people start to have more confidence in their own personal prospects and those of their family,” Hunt told the Financial Times in December.
Traders are no longer fully pricing in the first UK interest rate cut by August and now expect borrowing costs to start falling either that month or in September.
The major rethink by investors is also pushing up the cost of government debt, potentially reducing Hunt’s scope for pre-election tax cuts in an autumn “fiscal event.”
The 10-year benchmark financial charges rose to 4.2% from 4% in March and from 3.6% at the beginning of the year.
“What’s happening in the United States could have an effect here and influence forecasts,” one Conservative member said, referring to the Office for Budget Responsibility’s assessment of public finances.
Megan Greene, one of the most hawkish members of the BoE’s monetary policy committee, argued in the Financial Times on Thursday that investors had underestimated the risk that inflation would remain elevated for longer in Britain than in other advanced economies.
“In my view, rate cuts in the UK should be a ways off,” he added.
For Sunak, time is running out to start reaping the political dividends from what he will claim are the fruits of his sound economic management.
Conservative officials still hope that UK inflation will soon fall below the BoE’s 2% target – probably in May – and that next month’s growth data will confirm that Britain has emerged from mild recession in which it entered at the end of 2023.
They also point to seven months of real wage growth and the effects of Hunt’s cuts to national insurance – worth £900 a year for the average worker – trickling down to pay slips. Mortgage rates for people moving out of fixed contracts are already falling, they added.
But Labor, which plans to fight the election on the economy, believes that regardless of when the BoE cuts interest rates, voters will not be grateful to the Conservatives. “We’ll ask you a simple question: do you feel better?” said an ally of Rachel Reeves, the shadow chancellor.
Tomasz Wieladek, chief European economist at T Rowe Price, estimated that the latest rise in UK gilt yields would raise government interest costs by around 0.1% to 0.15% of gross domestic product compared to forecasts in the March budget.
Mark Dowding, chief investment officer at RBC BlueBay Asset Management, said: “This has a negative influence on UK public finances and impacts on politics. If we end up with rate cuts that don’t get delivered, it’s another nail in the coffin for the Tory party.”
Other economists believe a delay by the Federal Reserve in cutting rates in the United States could reduce pressure on the BoE to do the same in the United Kingdom.
“This makes it easier for the bank to put off difficult decisions and wait for further evidence that inflation is actually falling sharply,” said Ruth Gregory, deputy chief UK economist at consultancy Capital Economics.
But he added that the BoE could still choose to cut interest rates earlier and more than the Fed if inflationary pressures eased in the UK first – with its decision “determined not by the Fed, but by the domestic economy”.
Rob Wood, chief UK economist at consultancy Pantheon Macroeconomics, said he believes markets are “overreacting a bit” to US inflation data and expects the BoE to cut rates in June, September and December.