Policymakers at the Bank of England are prepared to lower interest rates and reduce economic growth projections, highlighting the dangers to Rachel Reeves' budget proposals.
Given the ongoing drop in inflation, it is generally anticipated that the nine-member monetary policy committee (MPC) would lower interest rates on Thursday by a quarter point to 4.5%, the lowest level since June 2023.
The decision will be accompanied by the Bank's quarterly evaluation of the economic outlook, which analysts anticipate would lower its 2025 GDP growth forecast from 1.5% to roughly 1%.
James Smith, of analysts ING, said a weaker growth forecast from the Bank would, “shine a light on the Office for Budget Responsibility, the body that polices the government’s fiscal policy”.
The first iteration of the OBR’s updated growth forecast landed on Reeves’s desk in the Treasury earlier this week, and will determine whether she is on course to meet her self-imposed fiscal targets.
“At the time of the October budget, the OBR expected growth of 2% this year, which looked optimistic at the time and has only grown more so since,” Smith said.
The chancellor is anticipated to disclose changes to her budget expenditure plans when she addresses MPs on March 26 if the OBR's latest predictions indicate that she is on track to violate her fiscal constraints.
Her statement was supposed to be a quick economic update, but government sources have made it apparent that she could propose spending cuts after changes in government bond markets threatened the £9.9 billion headroom the chancellor had left to comply with her regulations.
Reeves told journalists in Davos earlier this month: “We’ve asked the independent Office of Budget Responsibility to do a forecast that will be published on 26 March and at that point, I’ll be setting out any changes that are necessary.”
The chief secretary to the Treasury, Darren Jones, has repeatedly said Reeves’s fiscal rules were “non-negotiable”.
However, in more upbeat news for Reeves, the 10-year yield on government bonds, known as gilts, sank to about 4.42% on Wednesday – the lowest level since 16 December – as markets readied for lower rates. Higher yields feed through into higher interest rates on the government’s debt pile.
It is anticipated that Thursday's borrowing cost drop will be the first of multiple quarter-point rate reductions this year. The head economist of Panmure Liberum, an investment bank, Simon French, forecast up to six cuts in 2025, but he said the Bank would hold off on implementing a quicker rate of easing until political unpredictability subsided.
“We don’t think the pivot to a faster pace of UK rate cuts from the Bank of England is imminent. That will have to wait until the late summer in our view,” he said.
The Bank has made clear it will be monitoring the impact of Reeves’s October budget, which some firms have predicted could push up prices because of higher employment costs passed on to the consumer.
The MPC has ratcheted up rates from a low of 0.1% in 2021, as the economy struggled to recover from the Covid pandemic, to a peak of 5% in summer 2023 as inflation surged.
With growth stalling in the second half of last year, the Treasury will be hoping that fresh rate cuts from the Bank help to generate a feelgood factor, by cutting the cost of business and home loans.
However, Simon Pittaway, senior economist at the Resolution Foundation thinktank, said: “I would be surprised if there is a big boost to confidence on the back of one quarter-point cut.”
Reeves pledged last week in an Oxfordshire address to support a third runway at Heathrow and remove growth barriers like planning restrictions, but economists anticipate that these measures won't pay off for a few years.
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