Labour’s First Budget in Over 14 Years May Slow UK Interest Rate Cuts, Raising Inflation and Mortgage Rate Projections

0


In its first budget in more than a decade, Chancellor Rachel Reeves has introduced substantial tax increases and public spending hikes aimed at stabilizing the UK economy. Experts warn that the policy measures may alter the course of future interest rate cuts, with inflation and borrowing costs expected to see a modest uptick.

Unveiled in Wednesday’s autumn statement, Reeves’ budget includes £40 billion in tax hikes, targeting employer national insurance contributions and capital gains tax. Concurrently, government spending will increase by £70 billion per year over the next five years, with borrowing set to rise by an average of £32.3 billion annually. According to the Office for Budget Responsibility (OBR), these fiscal adjustments will lead to a peak inflation increase of about 0.5%, pushing the Consumer Price Index (CPI) up to 2.6% in 2025 before a gradual return to the 2% target.

In its latest economic outlook, the OBR revised inflation estimates, projecting CPI to be 1.1% higher in 2025 and 0.6% higher in 2026 than previously forecasted. This is attributed to persistent wage growth and increased demand resulting from the budget’s fiscal expansion. “We estimate budget policies will elevate inflation by 0.4 percentage points at their peak effect in 2026,” the OBR stated, noting that increased employer costs could pass through to consumer prices.

Despite a sharp decline in inflation—down to 1.7% in September, its lowest level since April 2021—the Bank of England (BoE) is anticipated to take a more cautious approach to rate cuts. After implementing its first rate reduction since March 2020 in August, the BoE opted to hold rates steady in September. Markets expect the BoE to announce another quarter-point cut at its upcoming November 7 meeting, but further cuts may slow due to the inflationary impact of the budget.

The OBR forecasts that interest rates will decrease from the current 5% to approximately 3.5% by 2027, with an average 0.4 percentage point rise in 2025 and 2026 compared to March projections. Joe Nellis, economic adviser at MHA, noted, “Interest rates are likely to fall more gradually due to this budget, although a year-end cut remains probable.” He added that public spending, higher minimum wages, and national insurance increases may elevate employment costs, exerting upward pressure on prices.

Market sentiment has shifted as traders now expect 95 basis points of rate cuts by the end of 2025, down from earlier forecasts of 125 basis points. Goldman Sachs analysts revised their outlook, suggesting the BoE might pause rate cuts at its December meeting, as stronger 2025 growth could reduce the need for immediate reductions. “While a rate cut remains possible with significant data surprises, especially on inflation, a pause now seems more likely,” Goldman Sachs economists noted.

Impact on Mortgage Rates

The OBR projects mortgage rates to rise from 3.7% in 2024 to a peak of 4.5% by 2027, aligning with expectations for higher bank rates. Laith Khalaf, head of investment analysis at AJ Bell, said, “The budget’s policies will likely add a modest inflationary effect, leading to higher mortgage rates. While some may recall the mortgage rate spikes following last year’s mini-budget, the current scale of gilt yield rises is notably milder and far from the panic observed in autumn 2022.”

This policy pivot marks Labour’s first significant economic intervention since assuming office, with implications that extend to household budgets, lending, and long-term financial planning. As the UK economy recalibrates to these changes, financial institutions and households alike are keeping a close watch on the evolving interest rate landscape.

Leave a Reply

Your email address will not be published. Required fields are marked *