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Tory election hopes fade with prospects for interest rate cuts

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Rishi Sunak’s hopes of going into a general election on the back of lower taxes and cheaper mortgages suffered a blow on Thursday as traders scaled back expectations of interest rate cuts in 2024.

Conservative officials admitted that unexpectedly high inflation data in the US on Wednesday was “concerning” and could have a knock-on effect for the UK economy and the party’s election strategy.

Investors are now betting on only two quarter-point rate cuts from the Bank of England this year, compared with expectations in January of at least six during the course of 2024 and about three in March, when chancellor Jeremy Hunt delivered his Budget.

That poses a potential problem for Hunt and Sunak, who hoped the BoE would start cutting interest rates well before a general election, widely expected in the autumn.

“That probably is the moment when people will begin to have more confidence about their own personal prospects and the prospects of their family,” Hunt told the Financial Times in December.

Traders are no longer fully pricing in the first UK interest rate cut by August and now expect borrowing costs to begin to fall in either that month or September.

International markets have also scaled back expectations of imminent rate cuts in the US and the eurozone. Traders in both regions have at least halved the number of interest cuts they anticipate this year compared with their expectations in January.

The European Central Bank kept rates at an all-time high on Thursday while signalling it was considering a cut at its next meeting in June.

The big rethink by investors is pushing up the cost of UK government borrowing, potentially reducing Hunt’s scope for pre-election tax cuts in an autumn “fiscal event”.

Benchmark 10-year borrowing costs have risen to 4.2 per cent from 4 per cent in March and 3.6 per cent at the start of the year.

“What’s happening in the US could have an effect here and affect the forecasts,” said one Tory insider, referring to the Office for Budget Responsibility’s assessment of the public finances.

Megan Greene, one of the more hawkish members of the BoE’s monetary policy committee, argued in the Financial Times on Thursday that investors had underestimated the risk that inflation would remain high for longer in Britain than in other advanced economies.

“In my view, rate cuts in the UK should still be a way off,” she added.

For Sunak, time is running out to start reaping political dividends from what he will claim are the fruits of his sound economic management.

Tory officials are still hopeful that UK inflation will fall below the BoE’s 2 per cent target soon — probably in May — and that next month’s growth data will confirm that Britain has exited the mild recession it entered in late 2023.

They also point to seven months of real wage growth and the effects of Hunt’s cuts to national insurance — worth £900 a year to the average worker — feeding through into pay packets. Mortgage rates for people coming off fixed deals are already falling, they added.

But Labour, which intends to fight the election on the economy, believes that regardless of when the BoE cuts interest rates, voters will not be grateful to the Conservatives. “We’ll ask a simple question: do you feel better off?” said one ally of Rachel Reeves, shadow chancellor.

Tomasz Wieladek, chief European economist at T Rowe Price, estimated that the latest rise in UK gilt yields would raise government interest costs by about 0.1 per cent to 0.15 per cent of gross domestic product compared with the forecasts set out in March’s budget.  

Mark Dowding, chief investment officer at RBC BlueBay Asset Management, said: “All of this has a negative influence on UK public finances — it feeds back into politics. If you end up with rate cuts that are not being delivered it’s another nail in the coffin for the Tory party.”

Other economists believe a delay by the Federal Reserve in cutting rates in the US could reduce pressure on the BoE to do the same in the UK.

“That makes it easier for the bank to postpone tricky decisions and wait for more evidence that inflation is indeed falling sharply,” said Ruth Gregory, deputy chief UK economist at the consultancy Capital Economics.

But she added that the BoE could still choose to cut interest rates earlier and further than the Fed if inflationary pressures subsided sooner in the UK — with its decision “determined not by the Fed, but by the domestic economy”. 

Rob Wood, chief UK economist at the consultancy Pantheon Macroeconomics, said he thinks markets are “overreacting a bit” to the US inflation data and expects the BoE to cut rates in June, September and December.


Source: Economy - ft.com

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