Unambiguously bleak Bank of England forecasts pave way for spending cuts | Bank of England

With the public finances tight and Rachel Reeves having pledged to balance the books, interest rate cuts are one of the few levers that could boost the UK’s economic growth in the short term, and the chancellor will be glad of the Bank of England’s quarter-point reduction on Thursday – and the clear signal that it is now in cutting mode.

Seven of the monetary policy committee’s (MPC) nine members backed the quarter-point drop, taking the Bank’s policy rate to 4.5%, while two wanted to be more “activist”, proposing a half-point cut. The Bank of England’s governor, Andrew Bailey, said the MPC would be “taking a gradual and careful approach to reducing rates further”.

Lower borrowing costs should feed through fairly rapidly to firms and households, compared with the impact from the runways, power stations and bridges that form the heart of the chancellor’s “plan for growth”. And against the right economic backdrop, rate cuts can act as a short-term mood-booster.

Yet the picture of the UK painted by the Bank’s quarterly inflation report, published alongside the 7-2 rate decision, is unambiguously bleak.

The MPC has halved its forecast for GDP growth in 2025, from the 1.5% it was predicting in November, to a sickly 0.75%. Economic output is expected to have contracted by 0.1% in the final three months of 2024 and expanded by just 0.1% in the current three-month period – narrowly skirting a recession, defined as two successive quarters of decline. Productivity, the Bank suggests – which Reeves badly wants to improve – has declined.

That assessment suggests a sharp downgrade by the Office for Budget Responsibility (OBR) when new forecasts are published on 26 March, from the 1.9% GDP growth it was predicting in October – potentially wiping out Reeves’s room for fiscal manoeuvre and prompting fresh spending cuts. And the MPC’s gloomy prognosis has not even factored in the potential downsides of Donald Trump’s trade tariffs, which it still regards as too uncertain to compute.

Even as economic growth bumps along the bottom, though, the MPC expects inflation to come surging back, driven by rising global energy prices, aided by increases in water bills and bus fares.

By the end of the summer, the Bank is forecasting inflation of 3.7% – well short of the 11% peak after the Covid pandemic and Russia’s invasion of Ukraine, but significantly above the Bank’s target. This uncomfortable combination of weak growth and higher prices, will inevitably lead to claims that the UK is sliding towards “stagflation”.

So what is the reason the Bank’s policymakers still feel able to cut rates, despite this jump in the pace of price rises? They believe the jobs market has now weakened so much that workers will be unable to bid up their pay to compensate, creating the kind of “wage-price spiral” that central bankers dread.

That may be reassuring for policymakers, but for the UK’s downbeat consumers, it is likely to mean another bleak year of stagnant living standards. The Bank reckons post-tax incomes will rise by a measly 1.25% in inflation-adjusted terms in 2025, and then by just 0.25% in each of the next two years.

For a government that has promised to create a stronger economy, which voters can feel in their pockets, the Bank’s forecasts suggest a very rocky period ahead, which no amount of pointing at shiny future infrastructure projects is able to smooth over.