While Chancellor of the Exchequer Jeremy Hunt came under severe pressure after his autumn budget statement, will his tax rises impact short-term interest rates? There is growing concern that delaying the worst tax rises for another two years will not help the Bank of England in its quest to control inflation. So, could there be more short-term pain before the tax increases have an impact?
Outlook for UK interest rates
There is speculation and counter-speculation that UK base rates could hit as high as 5% in the short to medium term. Alternatively, some analysts suggest rates could peak at around 4.25%. Opinion is undoubtedly divided! Interest rates are the primary tool with which the Bank of England aims to bring inflation back down towards its 2% target rate. Considering that consumer prices increased by 11.1% over the last year, and wage rises are at a 20-year high of 5.7%, this is a very challenging environment.
Initially, there were hopes that a mixture of austerity and tax rises would lead to a short-term peak in interest rates and then a gradual reduction. However, it now appears that austerity and tax rises won’t impact the Bank of England’s economic growth forecast until at least 2025. Moreover, as there is a time lag with inflation, it could be a further two years before these fiscal changes impact the inflation rate.
Economic growth
The Office for Budget Responsibility (OBR) believes the UK economy will fall by 2% over the next 12 months. However, in what many see as an optimistic outlook, the OBR forecasts a rebound and GDP growth of around 3% after that. Many were also surprised to see the OBR maintain its average 1.7% GDP growth over the next few years. Several analysts have pointed towards the USA, which is expected to fall into recession, no doubt impacting the worldwide economic outlook.
In the short term, the ongoing hike in US interest rates is forcing many central banks to follow suit to protect their currency. Moreover, the major economies are also on different timescales to recovery, which will see a divergence in fiscal policy in the short to medium term. These are challenging times!
Did Jeremy Hunt make the tough decisions?
While Jeremy Hunt made several tough calls in the Autumn Budget, the delay in introducing some of these changes is very interesting. In the short term, the Bank of England looks likely to increase base rates even further, with a 0.5% increase expected in December. Will this deflect from the government of the day and place even more focus on the Bank of England?
Is the UK in a recession?
According to the OBR, the UK is technically in recession, with the economy expected to contract by 2% over the next 12 months. After that, there are vastly differing views on how the economy will perform and what impact, if any, in the short-term, we will see from changes announced in the budget. Will politically motivated decisions see UK interest rates rise further and remain higher for a prolonged period?