Bank of England and Fed to cut interest rates despite fiscal fears
Investors are preparing for the Bank of England and the US Federal Reserve to cut interest rates tomorrow despite extensive political and economic uncertainty.
The Bank held rates at its last meeting in September, but signalled that further cuts were on the way if there continued to be progress on inflation.
Since then, the headline rate of inflation has fallen further than expected, while indicators of underlying price pressures have also eased.
Kallum Pickering, chief economist at Peel Hunt, said a cut would be “consistent with the guidance provided by policymakers” at the Bank of England’s last meeting.
A 25 basis point cut would mean the Bank Rate dropped to 4.75 per cent, down from the peak of 5.25 per cent which was reached last August.
Although investors have fully priced in a cut tomorrow, the key question for traders will be how the Monetary Policy Committee (MPC) factors in the impact of last week’s Budget.
Chancellor Rachel Reeves announced that spending would increase by £70bn compared to the last Conservative Budget, with two-thirds of this going towards current spending.
“The scale of the increase in spending is substantial,” David Miles, a member of OBR’s Budget Responsibility Committee, said in the wake of the Budget.
“It probably pushes the economy, at least for the next couple of years, a little bit into the territory of demand running a bit ahead of the supply capacity of the economy,” he said.
Budget impact will influence interest rates
Jumana Saleheen, chief economist at Vanguard Europe said, the Budget’s impact would be “top-of-mind” for rate-setters at the Bank of England.
“The Budget represented a large fiscal expansion,” she said. “Our modelling suggests this justifies removing around 25 basis points from the projected rate easing path over the next 12 months.”
Pickering likewise predicted that the MPC would emphasise that “the risks to the outlook for inflation are tilted to the upside” due to the measures announced in the Budget.
Investors also expect the Fed to cut interest rates by 25 basis points tomorrow despite the potential inflationary impact of a second Trump presidency.
Trump has threatened to impose blanket tariffs on foreign imports, likely pushing inflation as firms pass on higher costs to consumers. He has also promised extensive corporate tax cuts.
Chris Metcalfe, chief investment officer at IBOSS, said the inflationary outlook could “deteriorate significantly” due to his promised tax cuts and tariffs.
Although these concerns will not prevent the Fed from cutting rates tomorrow, analysts predicted that the Fed would have to slow the pace of rate cuts in 2025.
“Trump’s anticipated inflationary pressures may lead the FOMC to take a more cautious, wait-and-see approach in early 2025, assessing the impact of the new administration before further action,” Richard Flax, chief investment officer at Moneyfarm said.