The reaction of businesses to the budget is the “biggest issue” facing the Bank of England, according to its governor who is also contemplating the potential impact of Donald Trump’s looming return to the White House.
Andrew Bailey told an event that the future was clouded by domestic and global “uncertainty”, making it difficult to predict the effect on the UK economy, particularly around inflation.
He was speaking at the Financial Times’ Global Boardroom just a fortnight before the Bank is due to make its next interest rate decision.
The prospects for a third cut this year are grim, with financial markets betting there will be no change.
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All the mood music coming from Mr Bailey and his fellow rate-setters over the past few weeks has been cautionary, with the bulk of the public commentary talking of the need for a “gradual” approach.
The Bank is worried by a recent surge in inflation that has taken the rate back above its 2% target.
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Forecasts suggest it will keep going up in the coming months, towards 3% from 2.3% currently, amid renewed pressure from energy and services costs.
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Another headwind is the pace of wage growth which, the bank fears, will stoke inflation by boosting demand in the economy.
Mr Bailey said it was not yet clear what effect the hike to employer National Insurance contributions, announced in the budget and set to take effect in April, would have.
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“I think the biggest issue now in the immediate future is the response to the National Insurance change; how companies balance the mixture of prices, wages, the level of employment, what is taken on margin, is an important judgement for us.”
The budget raised employers’ National Insurance contributions by 1.2 percentage points to 15% and also lowered the threshold for when firms start paying to £5,000 from £9,100 per year.
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Businesses have responded by claiming it will hit wage settlements, investment and jobs.
They have also warned that the cost increases will be passed on to customers, potentially stoking inflation.
The retail sector alone says it faces an additional £7bn burden in 2025 from the changes while hospitality expects a £3.5bn hit. Both are major employers.
While weaker pay settlements could help the Bank bring down borrowing costs through interest rate cuts, policymakers will be worried about the threat of higher prices in the shops and in bars, restaurants and the like.
Mr Bailey said the Bank had laid out a “range of options” analysing the potential economic impact, “some of which would imply greater inflation and some of which would imply less inflation”.
“So there is uncertainty there and we need to see how the evidence evolves,” he said.
The other, global, pressure he spoke more about was the impact of the Trump presidency from late January when he is due to be sworn in for a second, and final, term.
The governor said that the Bank was also analysing the possible effects of threatened trade policies on the UK.
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Mr Trump has warned of tariffs covering all US imports as part of his agenda to protect US industry and jobs.
Mr Bailey said of such a scenario that it clearly “moves trading prices but it also depends on how other countries react to them, and how exchange rates react to them as well”.
He did not disagree, in an FT interview, that further interest rate cuts could be expected next year.
Financial markets are expecting up to four, barring any further shocks.
Mr Bailey described the process of falling inflation as being “well embedded”.
