(Bloomberg) — The Bank of England may ease interest rates as early as next month, but economists warned Prime Minister Keir Starmer’s new Labour government risks slowing down the shift away from the highest borrowing costs in 16 years.

Investors are pricing in chance of more than 60% that the central bank moves at its next meeting on Aug. 1. It would be the first cut since the start of the pandemic and will bring welcome relief to homeowners who have seen mortgage rates creep higher since the start of the year.

Economists are divided about the fiscal policies Starmer’s Chancellor of the Exchequer Rachel Reeves will adopt, particularly given the scale of Labour’s victory that gives the new administration a huge majority in the House of Commons. 

Reeves last night was vague about her plans, saying she’d “guide our economy through uncertain times” and “build prosperity that draws on the talents of working people,” adding that “the central mission of this new government will be to restore economic growth.”

Loosening the purse strings and a pledge to boost wages could stimulate inflation at a moment BOE policy makers are still on guard against price increases, potentially limiting the scope for future rate cuts. Others see fiscal constraints limiting the ambitions of Reeves, leaving the BOE a freer hand to prop up what’s recently been a sputtering recovery from last year’s recession.

“A Labour majority won’t do much to shift rate expectations – at least not at this juncture,” said Sanjay Raja, chief UK economist at Deutsche Bank. “There are risks to this view, however. Further net fiscal easing at the Autumn Budget than we’ve penciled in could lead to a more gradual rate cut path.”

After containing the worst bout of inflation in four decades, BOE officials led by Governor Andrew Bailey have been signaling the start of a rate-cutting cycle since February. With inflation back at the 2% target for the first time in almost three years, they’re willing to reduce the rate at which they’ve been bearing down on demand in the economy to prevent a wage-price spiral.

Bailey and the nine-member of the Monetary Policy Committee will be watching the Treasury’s budget and spending review in the autumn closely to see the scale of Labour’s tax and spending ambitions. Starmer has ruled out a return to austerity, and current projections from the fiscal watchdog suggest he would need to raise taxes or increase borrowing to achieve that unless he can fire up growth.

“Limited fiscal space will prevent a major shift in aggregate fiscal policy, even with a change in government,” said BNP Paribas economists including Matthew Swannell. “As a result, we think the outcome will have little bearing on the monetary policy outlook.”

Speed of Action

There’s a big debate about how quickly the BOE might act. Economists surveyed by Bloomberg last month were anticipating a cut in August, while markets haven’t fully priced in one until November. BOE policy makers have remained silent since the election campaign started six weeks ago, a period when inflation has fallen to target but underlying pressures, including in wages, remain too high for comfort.

The first clues will start emerging on Monday, with a speech from Jonathan Haskel, one of the nine members of the Monetary Policy Committee. BOE Chief Economist Huw Pill and MPC member Catherine Mann are due to speak later on Wednesday.

Some see the scope for sharper rate cuts if Labour moves quickly to plug a hole in the public finances. Governments often unleash painful spending cuts and tax increases early in their term, long before they have to return to voters for a new mandate. 

Ben Nabarro, chief UK economist at Citigroup, expects a “relatively tight fiscal approach upfront,” creating more spending firepower for later in parliamentary term and helping the BOE in their battle to keep inflation down.

“The post-election backdrop is likely supportive for gilts, dominated by early-term fiscal tightening alongside accelerating BOE easing,” Nabarro said. 

However, some suspect that Labour’s cautious campaign conceals a instinct for a more expansionary fiscal policy, which might lead to a slower shift to a lower bank rate.

George Buckley, chief UK economist at Nomura, said the size of of Labour’s win “might eventually encourage bolder fiscal policymaking in government than the manifesto promised.”

Ana Boata, head of economic research at Allianz Trade, said that a Labour government is likely to be “fiscally conservative,” particularly after the turmoil caused by unfunded tax cuts under former Prime Minister Liz Truss. But she puts a 20% chance on the new government being much more ambitious if it comes under pressure.

“If we go into this ambitious government scenario then most probably we will face some inflationary pressures,” she said. “Some of the measures would create more growth in the short run like defense spending, green investment, housing measures.”

Jobs Market

Another big variable is whether the Labour government tries to boost living standards by lifting pay. While unemployment has inched up in recent months, wage growth has remained stronger than the BOE would like, threatening to maintain inflationary forces. 

Labour’s manifesto suggested policies that might prolong upward pressures on pay, pledging to “make sure the minimum wage is a genuine living wage.” That follows an increase of almost 10% in April for the lower threshold of pay.

The central bank warned at its June meeting — its only communication to investors during the election campaign — that April’s rise in the National Living Wage “could be having a greater than expected impact,” as it also indirectly affects pay further up the pay scale. Economists fear businesses may pass on the cost of higher pay to consumers or let go of staff if salary bills become too painful.

“Labour’s pledge to introduce a ‘genuine living wage’ points to the possibility of stronger wage growth and some risk of slower rate cuts, but the magnitude of the change remains uncertain,” said James Moberly and Sven Jari Stehn, economists at Goldman Sachs.

The new government will also be under pressure to deliver on its promise to reduce net migration, though it has been vague on how sharp the drop in arrivals will be. A tougher clampdown risks tightening a labor market that was starved of staff following the pandemic, fueling wage growth further. 

–With assistance from Philip Aldrick and Andrew Atkinson.

©2024 Bloomberg L.P.

The post Starmer May Get a Boost From Bank of England Rate Cut Next Month appeared first on Bloomberg.