UK cuts interest rates for first time since 2020

The Bank of England cut interest rates for the first time since 2020 this month. The Bank Base Rate was lowered from 5.25% to 5% on 1 August after the Bank’s Monetary Policy Committee (MPC) voted by five members to four to reduce the rate by a quarter of a percentage point. This puts an end, for the time being, to the period of rising interest rates which started in 2021.

In deciding to vote for a cut in rates the MPC minutes note that the impact of previous shocks had abated, that inflation expectations had normalised and that there “had been some progress in moderating risks of persistence in inflation”. Although the members voting against noted that some economic news “suggested that second-round effects were having a greater impact on wage and price-setting behaviour in the economy”.

On the same day as the MPC made its interest rate decision the Bank also published its latest Monetary Policy Report which set out its thinking on the state of the UK economy ahead of that decision. In this it observed that although inflation had dropped to target it expects it to pick up later in the year “to around 2¾%”. However, this rise should be temporary with inflation expected to drop back next year. Looking at the prospects for UK GDP the Bank remains relatively downbeat with only modest growth forecast for the next few years. So, although the forecast for GDP growth in 2024 has been upgraded from 0.5% in their May forecast to 1.25% now, its forecast for 2025 and 2026 remains unchanged at 1% and 1.25% respectively.

UK inflation rises slightly in July

Despite the Bank cutting interest rates this month UK inflation numbers have picked up a notch, but as noted above this increase was generally in line with the Bank’s expectations. Consumer Price Index (CPI) inflation hit 2.2% in the 12 months to July 2024, up from 2.0% in June (Figure 1). This rate remains within the Bank’s central symmetrical target for CPI inflation of 2% ±1% and was below what most commentators had been expecting. Looking at the drivers of inflation the ONS noted that the largest upward contribution to the monthly change “came from housing and household services where prices of gas and electricity fell by less than they did last year; the largest downward contribution came from restaurants and hotels, where prices of hotels fell this year having risen last year”. Still beyond the headline rate other measures of inflation are continuing to slow. Core CPI (excluding volatile energy, food, alcohol and tobacco prices) inflation was 3.3% over the year to July 2024, down from 3.5% in June. The CPI goods annual rate remained negative but rose from negative 1.4% to negative 0.6%. The CPI services annual rate, fell from 5.7% in June to 5.2% in July; this was a greater drop in that measure of inflation than expected by most analysts.

Figure 1:

Despite inflation moderating from its recent highs, household finances continue to face challenging times. This was highlighted this month by the announcement of Ofgem that the household energy price cap will rise by 10% in October. This means that an average annual household energy bill would rise from £1,568 to £1,717. Analysts also expect a further rise in the cap in January.

UK GDP grew respectably in Q2 2024

The ONS has recently published data looking at the speed at which the economy grew in the second quarter of 2024. This data showed that UK GDP increased by 0.6% in the three months to June 2024, following growth of 0.7% in the three months to March 2024 (Figure 2). This follows on from two quarters of falling output at the end of 2023 which saw the UK enter a technical recession. Looking at a longer time frame UK GDP is 0.9% higher than it was in Q2 2023.

Figure 2:

However, despite GDP seeing growth in the second quarter of the year of the major sectors of the economy only the services sector saw output increase. Thus, the ONS observes that “in output terms, services grew by 0.8% on the quarter with widespread growth across the sector; this offset falls of 0.1% in both the production and construction sectors”. In terms of real GDP per head the ONS estimates it “to have increased by 0.3% in Quarter 2 2024 and is 0.1% lower compared with the same quarter a year ago”.

The Chancellor announces the existence of a large Government overspend

At the end of July the new Chancellor of the Exchequer, Rachel Reeves, unveiled the findings of an audit of public finances that she had commissioned post the general election. The audit “identified a substantial forecast overspend of £21.9 billion above the resource departmental expenditure limit (RDEL) totals set by the Treasury at the Spring 2024 Budget”. The sources of this overspend included “unfunded policy announcements”, the impact of inflation being higher than expected at the time of the 2021 Spending Review which set departmental budgets, events such as the war in Ukraine and public sector pay awards. The cost of the public sector pay awards, which have been accepted by the new government, amount to around £9.4 billion for the fiscal year 2024-25. While, there existed a £6.4 billion short fall in the asylum system and a £1.6 billion short fall in rail finances.

In response to this overspend the Chancellor announced a number of proposed savings and spending cuts. This includes asking government departments to find £3.2 billion in savings including stopping “all non-essential government consultancy spend in 2024-25 and halving government spending on consultancy in future years”. Further savings include not proceeding with adult social care charging reforms which were due to commence in October 2025, cancelling the Investment Opportunity Fund, cancelling the Advanced British Standard and reviewing previous commitments to some transport schemes and new hospitals.

A further major spending cut in the statement was the decision to target the Winter Fuel Allowance only to households in England and Wales with someone aged over the State Pension age receiving Pension Credit, Universal Credit, Income Support, income-based Jobseeker’s Allowance and income-related Employment and Support Allowance. City Intelligence Unit analysis of London data suggests that in 2022-23 970,000 pensioners received a Winter Fuel payment in London. While, in the quarter ending February 2024 there were 190,000 active Pension Credit claims in the capital.

UK economy has seen slow income growth, rising poverty, and growing inequality according to the Institute for Fiscal Studies

The UK economy is facing significant challenges, as highlighted by a recent report from the Institute for Fiscal Studies (IFS). The report covers the period from 2019-20 to 2022-23, indicating that the past few years have been characterized by very slow income growth, increasing poverty among low-income groups, and rising inequality. These challenges have been largely accelerated by the COVID-19 pandemic and the subsequent cost-of-living crisis, making this one of the slowest periods of income growth in recent UK history.

The IFS analysis shows that during this period, poorer households initially experienced income rises due to government interventions during the pandemic. However, when these temporary measures were withdrawn, these households faced a more severe fall in income. Specifically, income for the poorest third of households remained flat between 2019-20 and 2022-23, while the middle-income group saw a real-term decline of 2%. Among higher-income households, there were small declines, contributing to the stagnation of income growth since 2007-08. The inequality gap has not narrowed significantly and living standards of poorer households have only modestly improved.

Poverty rates exhibited mixed trends during the period from 2019-20 to 2022-23. Absolute poverty increased marginally to 18%, remaining close to the levels seen before the pandemic, while relative poverty fell slightly to 21%. However, the report highlights an exceptionally high increase in material deprivation. For example, the proportion of working-age adults unable to afford adequate heating rose dramatically from 4% to 11%. This sharp rise in material deprivation reflects the significant economic pressures on lower-income groups, pressures that are not fully captured by traditional poverty indicators.

The report goes on to describe other limitations related to measuring price rises, such as the impact of floating mortgage interest rates. Thus, ignoring interest rate rises lead to an underestimation of the cost pressures for holders of mortgages. This mismeasurement issue is a growing concern as interest rates have increased markedly since December 2021, with an increased likelihood of financial stress for households with mortgages.

The report does however show that average incomes have increased in real terms among pensioners from 2011-12 to 2019-20, but that this has not translated to material poverty reduction among poorer pensioners. This is because intra-pensioner inequality is increasing, and hence, pensioners without private pensions or savings experienced slower growth in incomes.

The global economy is at a crossroads

In the United States, there has been a rise in economic uncertainty. Following a year of robust growth some signs of an economic slowdown have appeared underpinned by rising unemployment and slowing job growth. Recent data from the US Bureau of Labor Statistics indicated that job growth was weaker than initially estimated, with revisions showing that 818,000 fewer jobs were added between April 2023 and March 2024 than previously reported. Additionally, the unemployment rate has shown signs of edging higher, further compounding concerns about the health of the labour market. Minutes from the July Federal Reserve meeting indicate that future interest rate cuts may occur, driven by labour market weakening and the cooling of inflation. This would show that officials at the Fed are more concerned that waiting too long will give the slowdown room to worsen.

Elsewhere although inflationary pressures have started to come off the boil, uncertainty remains about the future pathway of inflation. For example, the European Central Bank (ECB) also hinted that it may cut interest rates as early as September, despite persistent core high inflation but that this will depend on the evolution of the economy’s performance. In stark contrast, Brazil and India are two economies still battling persistent inflation, with Brazil’s inflation rate hovering around 4% and India’s at approximately 6.4%. This persistence makes the decision for their central banks on balancing growth versus price stability more cumbersome, as Brazil’s Selic rate remains at 13.75% and India’s repo rate at 6.50% despite global trends towards easing.

Fanning global economic concerns are the major labour disputes unfolding across North America and in India, heightening the prospect of supply chain disruptions worldwide. Those would ripple out widely, with particular concerns for the US as the holiday season drives up the cost of goods delivery and delays. The International Longshore and Warehouse Union’s (ILWU) strike involves over 22,000 workers, potentially impacting ports like Los Angeles and Long Beach, which handle about 40% of US imports. US Treasury Secretary Janet Yellen recently warned that “any significant disruption could have ripple effects across the US economy, particularly during peak consumer demand periods”. Similarly, World Bank President Ajay Banga emphasized that “supply chain disruptions in major economies have global implications, potentially slowing recovery efforts in developing nations and increasing inflationary pressures worldwide”.

The indicators for London’s economy remain positive

Despite the challenges that the UK and international economies continue to experience the economic picture in the capital shows signs of strength. This can be seen from the various indicators summarised in the economic indicators section of this publication. Thus, the Purchasing Managers Index (PMI) for new business and employment has shown an expansion for all of 2024 so far, while new business activity has been expanding since 2022. Consumer confidence has also been marginally positive for the past few months. However, other indicators do add a note of caution. For example, the ONS estimates that unemployment in London has recently picked up although it still remains relativity low by historic standards.

GLA Economics will continue to monitor all these issues over the coming months in our analysis and publications, which can be found on our publications page and on the London Datastore.

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