Week of 11th September- 18th: Bank of England Faces Pressure Amid Inflation, Economic Slowdown, and Fiscal Challenges

Section 1: UK:

The Bank of England (BoE) faces increasing scrutiny as traders speculate that it may lower interest rates by 0.25 percentage points. While the central bank is more likely to keep rates steady at 5%, upcoming inflation data and potential moves by the U.S. Federal Reserve could influence its decision. The UK's economic landscape, marked by a mix of slowing wage growth, rising airfares, and a stronger pound, presents a complex backdrop for the BoE. Alongside this, concerns over savings rates, inflation, and fiscal policies highlight the ongoing challenges facing the UK economy.

Bank of England and inflation:

Traders increasingly bet the Bank of England will lower interest rates by 0.25 percentage points on Thursday. The BoE is still more likely to retain interest rates at 5%. Still, if the Fed cuts rates and the UK's inflation data (coming Wednesday) surprises to the downside, the BoE may feel pressured to follow suit, especially since a stronger pound might harm UK exports.

Citi economists advocate for a BoE rate decrease due to weak economic data and slowing wage growth, but some traders believe continuing service inflation will limit rate cuts. After peaking at more than 11% in 2022, inflation remains close to the Bank of England's 2% objective. Rising airfares were key inflation drivers, although reduced gasoline prices and weaker restaurant and hotel charges countered the increase.

Furthermore, the Financial Conduct Authority has asked banks to provide more competitive savings rates, warning of severe penalties for noncompliance. Despite a recent £4 billion increase in savings, the FCA voiced worry that banks may lower rates faster than they raise them, reducing consumer savings.

Labor Market:

In the labour market, job openings have increased slightly despite continued shortages, particularly in the healthcare and technology industries. However, recruiting has been hindered by high interest rates and an imbalance of applicants' skills. According to reports, there has been a rise in applications, which has made it harder for businesses to fill open positions.

Wage growth slowed, and the UK economy failed to gather traction. While inflationary pressures linger, BoE officials expect inflation to fall, potentially allowing for faster rate cuts this winter.

Tax:

Barclays has urged for reforms to make UK public markets more appealing to investors, including tax breaks for companies that transition from junior exchanges like Aim to the main market. The bank's research suggests reconsidering the 0.5% stamp tax on share sales, which raises £3.8 billion each year but is viewed as a barrier to investment. Barclays claims that abolishing the prospectus requirement for firms shifting to the main market after 18 months on a junior exchange as well as extending investor tax breaks would encourage growth-stage companies to list publicly in the UK. These steps are intended to bolster the UK equity markets, which have been losing companies to overseas listings or private ownership.

UK business leaders are concerned that the Labour government's tax-raising plans and harsh talk about the economy may impede efforts to attract private sector investment. While the government seeks to enhance infrastructure and economic growth, CEOs are concerned that the government's negative tone, particularly that of Chancellor Rachel Reeves regarding the financial disaster left by the previous Conservative government, would deter overseas investors.

Labour intends to introduce tax rises, potentially targeting private equity, capital gains, and inheritance taxes, prompting concern ahead of the October Budget. Business executives are especially concerned about the timing of an impending international investment gathering, which they believe may coincide with the proposed tax increases.

Fiscal Debt:

The UK Treasury is delaying information about the claimed £22 billion fiscal "black hole" revealed by Chancellor Rachel Reeves, arguing a need for more time to assure accuracy. The Labour government has been criticised for its transparency, particularly over the impact of means-testing winter heating subsidies for 10 million pensioners. While Reeves blames the deficit on Conservative mismanagement, certain elements, such as £9.4 billion for public sector pay and an asylum overrun, have been disclosed. However, the £8.6 billion "normal reserve claims" segment is not fully broken down. Critics contend that the government is not being completely honest, with some claiming the "black hole" is an excuse for tax increases.

Starmer emphasised the significance of stabilising public finances to foster economic growth, implying that difficult decisions will be made upfront. However, he is wary about lowering public investment, heeding experts' warnings against doing so. While he acknowledged the need for fiscal regulations, he also expressed a readiness to accept borrowing for investment as long as it is consistent with fiscal discipline. He has ruled out hikes in income tax, VAT, company tax, and employee national insurance, but he may explore raising capital gains tax and taxes on banks and the wealthy.

Upcoming Budget:

Andy Burnham, Mayor of Greater Manchester, has urged the UK Treasury to shift its focus from managing spending to encouraging economic growth, especially given spending reductions are expected in the budget. Burnham said that releasing investment in infrastructure, particularly transport projects outside of London and the South East is critical to stimulating growth. As the budget approaches, Labour must balance investment demands with warnings from the Office for Budget Responsibility about rising public debt caused by factors such as an aging population and climate-related costs. 

Winter fuel cut:

Keir Starmer dodged a significant mutiny within his Labour party by gaining a 120-vote majority in the House of Commons for his contentious plan to reduce winter fuel subsidies for 10 million pensioners. Despite opposition concerns that the measure might injure vulnerable elderly people, only Jon Trickett, a Labour MP, voted against it. The strategy hopes to save £1.5 billion a year.

Though Starmer won a convincing victory, his government is facing mounting criticism. Trade unions, including the RMT, led by Mick Lynch, have criticised Labour's leadership style. In addition, select committees and Labour peers in the House of Lords may scrutinise future measures, potentially derailing them. Concerns are also growing within the party about preserving public support, particularly as the next election approaches and Starmer's popularity declines. Starmer's priority is to implement "painful" policies as soon as possible to avoid more backlash, but keeping party discipline and dealing with criticism will be difficult.

In the Conservative leadership race, Robert Jenrick emerged as the frontrunner after the second ballot, while Kemi Badenoch's chances appear weakened. Candidates will have a final chance to present their vision at the Conservative party conference, where a standout 10-minute speech could turn the tide, much like David Cameron’s in 2005.

Prison Officers Strike:

UK authorities have rejected proposals by the Prison Officers' Association (POA) to reinstate the ability to strike for prison guards in England and Wales, despite concerns that the decision will exacerbate the problem in overcrowded prisons. The POA has requested Prime Minister Keir Starmer to abolish a 1994 statute that prohibits prison guards from striking, citing understaffing and bad working conditions.

While the Trades Union Congress (TUC) argued that prison staff should have the same ability to strike as their colleagues in Scotland, the Ministry of Justice had no plans to reconsider the legislation, citing a recent 5% wage increase for officers. However, the POA maintains that this salary rise will not alleviate the recruiting and retention challenges. 

International Relations:

Ongoing post-Brexit trade negotiations with the European Union (EU). Talks have intensified over trade regulations and tariffs, with particular tension arising over fishing rights. Coastal communities have called for the UK government to adopt a firmer stance as disputes over access to UK and EU waters continue to impact the fishing industry.

Additionally, the UK is preparing for a major international investment summit aimed at attracting foreign investors. However, concerns over proposed tax hikes from the Labour government have sparked anxiety among business leaders, who fear this could hinder the UK's attractiveness as an investment destination.

NHS:

An official investigation led by Lord Ara Darzi stated that England's NHS is in "critical condition" as a result of years of underfunding, mostly caused by austerity policies in the 2010s. The analysis showed that the NHS spent £37 billion less on infrastructure than peer countries, resulting in insufficient resilience, particularly during the COVID-19 pandemic. Staff disengagement, excessive illness absence rates, and delayed care have exacerbated the system's load. Prime Minister Keir Starmer promised reforms, including shifting the focus away from hospitals and towards community care and prevention. The assessment also criticised previous Conservative healthcare measures for aggravating inefficiency.

Prime Minister Sir Keir Starmer has stated that the NHS will receive "no more money without reform" and warned that it will take a decade to repair the health sector. Wes Streeting, the Health Secretary, also promised to decrease waiting lists by millions within five years while pushing for broader NHS changes.

The Institute for Public Policy Research proposes raising tobacco, alcohol, and unhealthy food taxes to raise £10 billion per year by the end of the decade to improve public health. The panel, chaired by former health authorities, highlights the relationship between health and economic difficulties, pointing out that around 900,000 working-age people are absent from work owing to illness, costing the government £5 billion in lost tax income.

The report urges for stronger rules on food packaging and gambling advertisements, as well as a shift in NHS financing to prevention rather than hospital care, which presently accounts for more than half of the NHS budget. The proposed changes include establishing a "right to try" for disability benefits and a well-being premium to encourage supporting employment. The research also highlights the need for legislation to increase healthy life expectancy by ten years over the next thirty years. Overall, the proposals are intended to foster a healthier society that promotes economic progress.

Energy:

According to an energy report by Wood Mackenzie, oil and gas output in the UK's North Sea might be cut in half by 2030 due to tax measures that would severely hurt the business. Companies would pay a 78% tax beginning in November as a result of an increase in the Energy Profits Levy, which was implemented following Russia's invasion of Ukraine. The sector is also at risk of losing capital expenditure and investment allowances, which adds to the uncertainty that is holding back new investments. According to Wood Mackenzie, these tax reforms may wipe away £19 billion in development capital and reduce production by 50%, with even a more favorable scenario resulting in a 30% decline.

The report warns of irreversible damage to the industry, with smaller enterprises likely to fail and large decommissioning expenses borne by partners and possibly the UK government. While oil and gas taxes raised £9.8 billion in 2022–23, revenues are likely to fall as North Sea projects dry up. Industry organisations and consultants argue that the UK does not have time to change its policy, putting employment and future investments at risk.

Since 2010, fuel duty has been effectively lowered by 40%, costing the Treasury more than £100 billion and contributing to increased pollution, lower electric car sales, and reduced public transport use. Both Labour and the Conservatives have avoided increasing fuel duty, with Labour promising not to increase taxes on working people and the Conservatives ruling out road.

Conclusion: 

As the Bank of England navigates various pressures—from high inflation and a weakening economy to external global factors—the direction of interest rates remains unknown. Labour market limits, tax reforms, and energy production concerns all have an impact on the overall economic picture. With inflation approaching the target and fiscal issues looming, the decisions made by UK policymakers in the next few weeks will have far-reaching consequences for the economy's stability, investment prospects, and public confidence.

Written by Sabina Rahman