Budget borrowing will slow Bank of England rate cuts, economists warn

Economists have cautioned that increased government spending could likely cause the Bank of England to decelerate the rate of interest cuts over the next year.

Chancellor Rachel Reeves is aiming to generate £40bn in the forthcoming week's Budget to support increased public service spending, primarily through tax hikes, as reported by City AM.

In addition to these measures, it is probable that Reeves will modify fiscal rules to permit more government borrowing for public investment.

Pantheon Macroeconomics' economists stated that the "growth-depressing impact" of higher taxes would likely be "roughly cancelled out" by the enhancement to everyday spending.

However, the anticipated increase in investment will provide a larger boost to growth. "Government investment has a much bigger impact on GDP growth than tax hikes do," said Rob Wood, chief UK economist at Pantheon Macroeconomics.

Wood predicts that Reeves will augment borrowing by an average of £17.2bn annually over the next three years, providing a 0.5 per cent boost to GDP in 2025/26.

Consequently, he estimated that the Bank Rate would need to be 50 basis points higher in 2025/26 compared to what it would have been under the previous government's fiscal plans.

"The MPC can keep cutting interest rates, but Ms. Reeves' Budget should keep rate-setters easing policy only gradually," he commented.

Analysts at Capital Economics concurred that an increase in public investment would complicate matters for rate-setters at the Bank of England.

Paul Dales, chief UK economist at Capital Economics, has stated: "The direct boost to GDP from a rise in public investment over the next few years would raise demand relative to supply. That could mean inflation is a bit higher than otherwise and interest rates are cut more slowly," However, Dales also argued that a well-directed investment programme would increase supply capacity in the long term, potentially leading to slightly lower interest rates.