by The market reaction to today’s interest rate cut from the Bank of England was very interesting indeed.
Sterling, as one might expect, fell against both the dollar and the euro – although some market participants raised hopes that most of the decline came against the green backdrop, especially before news broke that he had the monetary policy committee (MPC). Bank rate cut.
Even more significant, however, was the fall in yields on gilts – UK government bonds – which also act as implicit government borrowing costs.
Money latest: Reaction as Bank of England cuts borrowing costs
The yield on 10-year gilts, which was as high as 4.293% at the start of July, fell to 3.906% – a level not seen since 12 March.
The yield on 5-year gilts, as high as 4.121% a month ago, fell to 3.674% – a level last seen on 1 February.
It’s now down almost 6% just this week – quite a drop as these things go.
And the yield on 2-year gilts, which tend to be the most sensitive to short-term interest rates, fell from 4.262% as recently as early July to 3.717% – a level last seen on May 17 last year.
In theory, these moves should be good news Rachel ReevesThe new Chancellor of the Exchequer.
Interest payments on the national debt were forecast by the Exchequer (at outgoing Chancellor Jeremy Hunt’s spring budget) to come in at £109bn this financial year – making it the fourth highest element of spending government this year after social security, the NHS and education. .
So anything that reduces government borrowing should, all else being equal, free up more money for other things – higher public spending, tax cuts or, more simply in the current environment, borrowing by the bring down governments.
This was already happening, to some extent, because 28% of the interest payable on the national debt is fixed on the old RPI measure of inflation. But lower gilt results in the round would make Ms Reeves’ job much easier.
Except that it also gives the new chancellor a political headache.
In her Statement from the Houses of Com on MondayMiss Reeves has sought to reduce road and rail spending cuts, as well as decisions to reduce the proposed cap on social care costs and remove 10 million pensioners from the winter fuel allowance, to a £22bn fiscal hole she claims which she inherited from him. Mr. Hunt.
That was not entirely true: around £9.4bn of that deficit was created by her own decision, also announced that evening, to wage increases that outpace manual inflation for millions of public sector workers.
But the speech previewed how Ms Reeves will present her upcoming October budget which, as she confirmed on Tuesday, is likely to include further tax increases.
It is clear that the chancellor intends to frame those tax increases as an unpleasant decision made by the state of the public finances. Something she would rather not do if the circumstances were better.
However, if the government’s borrowing costs continue to fall – and the market is pricing in at least one more rate cut from the Bank of England this year – it becomes harder for Ms Reeves to make that argument, as she will be cutting back less money on. interest payments.
It would suggest that Ms Reeves is doing less because of the increase in inheritance tax and a raid on the tax relief that people get from their pensions because of more controversial measures which the public is softening towards. she was forced to – but because she chose to do them on purpose.
This may explain why, in response to the Bank of England’s move this lunchtime, Ms Reeves reacted somewhat defensively.
She said: “I am focused on making the difficult decisions to fix the foundations of our economy.”
The Chancellor also pushed back on suggestions that the pay rises she handed out on Monday would fuel inflation.
She said: “It is up to the Bank of England to make their decisions about interest rates and forecasting inflation. I made the decision on Monday… to give our armed forces, police, teachers, doctors and nurses a pay rise nurses – I. think that is the right thing to do.
“But we also found efficiencies in government spending to offset some of that wage increase.”
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Andrew Bailey, the governor of the Bank of England, found himself having to answer similar questions when he and his colleagues faced the press to explain today’s decision.
When asked whether the pay rises awarded by Ms Reeves this week would be inflationary, the governor said: “First of all, we would be leading in terms of private sector wage indicators, because private sector wages are directly contributing to consumer price inflation. .
“But public sector wages clearly affect demand and can have a signaling effect. Overall, I think private sector wages tend to lead public sector wages and that’s what we’ve seen for a while.
“The second point I will make is… if you do a very simple ‘back of the envelope’ on the public sector pay increment announced by the Chancellor… the proverbial back of the envelope suggests an increase in inflation… which is very small – you’re in a relatively small number of the second decimal place.”
This suggests that Mr Bailey is quite confident that the pay rises will not add to inflation in the coming months.
But there is little doubt that this could, perhaps, make the MPC’s decision more difficult.
Meanwhile, expect Ms. Reeves to reject, at every turn, the notion that lower government borrowing costs will negate the need for tax increases.
