The Bank of England Kwasi Kwarteng warned that the economy is in the doldrums and will likely need to raise interest rates after Friday’s tax cut mini-budget.
On the eve of a major support package from the Chancellor of the Exchequer aimed at breaking what he called a “stagnation cycle” in the economy, Threadneedle Street said the British economy is heading for a second consecutive quarter of lower production, with GDP expected to contract. 0.1% in the three months to September.
However, with energy and food bills still rising, and inflation not expected to peak until October, the Bank of England raised borrowing costs for the seventh consecutive meeting of the Monetary Policy Committee (MPC) and made clear that the new government’s plans risked triggering further rate hikes.
MPC – any Raising interest rates by 0.5 percentage point to 2.25% on Thursday — it said it would carefully assess the impact of government energy price ceilings and the growth plan before the committee’s next decision in November.
In a letter to the Chancellor of the Exchequer explaining why inflation has risen to nearly five times its 2% target, Bank Governor Andrew Bailey said: “If expectations point to further persistent inflationary pressures, including increased demand, the Committee will respond aggressively, when necessary.”
Kwarteng on Friday will announce 30 separate measures – including tax cuts, new investment zones and acceleration of infrastructure projects – in a bid to raise the economy’s growth rate to its stated target of 2.5% annually.
One of the key elements of the package – a reversal of the £13 billion increase in National Insurance contributions, which was introduced in April to fund health and social care tax – will take effect on November 6, three days after the bank’s next interest rate decision.
While nearly 28 million people will keep more of their earnings as a result of the move, the Resolution Foundation think tank said the poorest 10% of households will earn an average of £11.41 in 2022-23, while the richest 10% of households Families will earn £. 682.
The mini-budget is expected to contain significant additional growth-boosting interventions beyond the reversal of the NIC’s rise and next April’s planned increase in corporate tax, Treasury sources confirmed, with a British government source describing the package as having “more rabbits than the Watership Down”.
A key component of the financial event will be new investment zones for 38 local and presidential authorities in England – including the West Midlands, Tees Valley, Somerset and Hull – which will have significant planning liberalization to release more land for housing and commercial development, and tax cuts for businesses.
The district’s investment plans include a number of controversial measures such as removing the need for developers to meet affordable housing goals, as first revealed by The Guardian. Environmental regulation will also be reduced in these areas.
Kwarteng will defend plans to raise the banker’s bonus cap and ban on fracking, saying the government will be “bold and not shy in the pursuit of growth – even when that means making tough decisions”.
He will also announce measures to speed up the delivery of about 100 major infrastructure projects across the country which he will say have been unnecessarily delayed by bureaucracy.
The chancellor will tell MPs: “Growth is not as large as it should be, which has made it difficult to pay for public services, requiring higher taxes. This recession cycle has led to projections of the tax burden reaching its highest levels since the late 1940s.”
We are determined to break this cycle. We need a new approach for a new era focused on growth. This is how we will provide higher wages, greater opportunities and sufficient revenue to fund our public services, now and in the future.
This is how we will successfully compete with dynamic economies around the world. This is how we will turn the vicious cycle of stagnation into a virtuous cycle of growth.”
Pat McFadden, the Treasury’s chief shadow treasurer, said the amounts involved were extraordinary without any examination of how they were funded, other than borrowing.
“Their choice to finance all of this through borrowing and not trying to finance even part of it through a windfall tax on energy companies getting the most out of the current crisis increases risks and leaves British taxpayers paying more for longer,” he said.
Announcing its latest rate decision, the Bank of England said the energy price guarantee, which sets household bills, will mean inflation will peak at just under 11% this autumn rather than above 13%. Although the CPI eased slightly from 10.1% in July, to 9.9% in August, it is still at a level not seen since the early 1980s.
However, Bailey said in his letter to Kwarteng that government support measures risk increasing upward pressure on the cost of living. All else being equal…this will add to inflationary pressures in the medium term,” Bailey wrote.
After a 0.1% drop in gross domestic product in the three months to June, the bank said an additional 0.1% decline is now expected in the third quarter amid a dip in consumer spending and weak manufacturing and construction activity.
She said the decline also reflected a less-than-expected recovery from the extra bank holiday for the Queen’s platinum jubilee, as well as the impact from businesses closing their doors in a sign of respect for this week’s state funeral. An economy is technically considered to be in a recession if it has experienced two consecutive quarters of negative growth.
Susanna Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: “The starting whistle has been sounded on the economic tug of war between the Bank of England and the Liz Truss government.
“The BoE’s Bailey team wants to take demand out of the economy, to try to stop the price spiral, while the Truss team wants to stimulate it, and they risk prolonging the pace of rate hikes.”