So, how realistic is that May rate cut? We think for it to happen, three things might need to happen.
The first is that services inflation needs to show more progress, and in the near term, we think it will remain stuck between 6-7%. The March figure, which will be the last reading available before the May meeting, will probably be only slightly below that. Wage growth, which is the other key metric the BoE has its eye on, should show a little more progress, but surveys suggest this is also likely to be pretty gradual in the near term. Better news should follow on both services inflation and wage growth in the second quarter. But we think it would take a string of additional downward surprises here to convince the Bank to cut imminently, something it currently appears highly reticent to do.
The second thing to watch is the government’s Spring Budget in March. We wrote last week that we think the recent fall in market rates will give the government roughly £12bn extra to spend while still meeting its major fiscal rules. That comes in addition to the £13bn “headroom” left over from November’s Autumn Statement and, in total, gifts the government with as much as 1% of GDP in fiscal stimulus to play with if it so wishes.
A large fiscal boost in March may well be cited as a reason for the BoE to wait until the summer before cutting rates
The government is widely expected to spend at least some of that in the March budget, and press reports suggest an income tax cut is a likely candidate for that stimulus. The question is how large the fiscal injection is at this point and whether the government intends to split it in two with another budget closer to the widely-anticipated autumn election. The Sunday Times recently reported that the government was considering having a second budget event just before campaigning begins.
This detail potentially matters for the Bank of England, which bases its interest rate decisions on whatever government policy officially is at the time. A large fiscal boost in March may well be cited as a reason for the BoE to wait until the summer before cutting rates. This is a key factor in our call for rate cuts to start in August. But a more muted fiscal package could keep a May cut in play.
