Week of September 18-25th: Navigating Economic Shifts: Inflation, Mortgage Rates, and the UK's Investment-Driven Budget

The UK economic landscape is witnessing several critical developments, including the Bank of England altering its monetary policies in reaction to inflation, rising mortgage rates, and significant policy pronouncements from the government. As inflation stays stable but presents fresh hurdles in specific areas, the bank balances quantitative tightening with consumer spending worries. Mortgage rates are changing in anticipation of rate decreases while the government prepares a Budget that prioritises investment-driven growth. This article dives into these linked economic transformations, as well as the political and fiscal processes that shape the UK's future.

Bank of England:

While UK inflation stays at 2.2%, close to the Bank of England's 2% target, service inflation has risen marginally. The BoE expects inflation to reach 2.5% by the end of the year, with modest economic growth. The Bank of England's quantitative tightening policy remains unchanged, to reduce bond holdings by £100 billion in 2024–25. They also evaluate alternative economic scenarios, considering global shocks and persistent inflation that may require extended tighter monetary policy. Governor Andrew Bailey emphasised that any future rate cuts would be gradual and unlikely to reach the record low levels witnessed during the pandemic.

Furthermore, Megan Greene, a senior policymaker at the Bank of England, suggested that the pace of interest rate decreases may need to moderate if the population wants to spend more freely. She proposed several explanations for low consumption, such as households may be saving due to concerns about rising living costs, higher interest rates, a weaker job market, etc. Greene warned that if consumer confidence and spending rise, inflation may rise, needing a longer period of tight monetary policy.

Mortgage Rates:

Two-year fixed mortgage rates are falling quicker than longer-term rates as markets anticipate interest rate reductions from the Bank of England. Santander just became the first big lender to provide a two-year mortgage for less than 4%, lowering its rate to 3.99% for purchasers with a 40% down. Historically, five-year rates were lower than two-year rates, but the difference is closing due to changing market expectations regarding the BoE's rate-cutting cycle.

It is predicted that by the end of 2024, five-year mortgage rates will be down to 3.5%, while two-year rates will be at 3.8%. Mortgage pricing follows interest rate swaps, which have decreased quicker for shorter terms as markets anticipate the BoE's rate reduction will be finished within two years. Major lenders, including HSBC and NatWest, have lately lowered interest rates. The average two-year mortgage rate has fallen from 5.64% to 5.47% during the last month. 

Upcoming Budget:

At the Labour Party convention, Chancellor Rachel Reeves revealed plans to increase government capital spending, emphasising that "growth is the challenge, and investment is the solution." She wants to move beyond a focus on costs and recognise the rewards of investment, implying a possible change in fiscal laws to allow for increased capital spending. Reeves defended her decision to prioritise public investment, despite limits imposed by existing debt laws, and expressed a desire to create new criteria for quantifying investment gains.

During her speech, she reassured participants about her hopeful outlook for the economy, stating that the next budget would prioritise economic development and investment. She also announced intentions to speed the implementation of free breakfast clubs in primary schools, beginning in April 2025, as part of a larger commitment to improving prospects for future generations.

Sir Keir Starmer has positioned his administration for a major rise in capital spending in the forthcoming Budget, bolstered by the OECD's support for changes targeted at increasing public investment for economic growth.  Speaking before the United Nations General Assembly in New York, Starmer emphasised the role of government spending as a stimulant for private investment, calling for borrowing to fund capital projects rather than day-to-day expenses.

On October 30, Chancellor Rachel Reeves will introduce amended fiscal rules aimed at encouraging significant investments in green energy, infrastructure, and healthcare. Reeves had previously hinted at increased capital spending at the Labour Party convention, citing the need to fight "low investment that feeds decline." The administration is looking into ways to alleviate fiscal restrictions, such as recognising the benefits of investment and adopting other metrics of government balance sheets.

While the OECD predicts that the UK's GDP will expand by 1.2% in 2024 and 1% in 2025, it also warns of continuously high inflation relative to other G7 countries, with averages of 2.7% in 2024 and 2.4% in 2025.

Political Landscape:

The frontrunner in the Conservative Party leadership election, Robert Jenrick, has accused the Treasury and the UK's fiscal watchdog, the Office for Budget Responsibility, of misleading the public about the economic benefits of migration. Jenrick, a former immigration minister, claimed that mass migration had artificially increased GDP while hiding larger economic decline and harming housing, wages, and public services. He suggests limiting net migration to 100,000 per year and withdrawing the UK from the European Convention on Human Rights. Jenrick has also criticised previous Conservative governments, including his own, for neglecting to address these concerns, claiming that the OBR's analysis shows low-wage migrants are a drain on public budgets, despite their lifetime contributions. 

Furthermore, on another note, Sir Keir Starmer has come under fire for first failing to properly report £16,200 in work attire received from Labour contributor Lord Waheed Alli. Starmer initially classified the donation as "private support" for his office but later updated it to appropriately reflect it as a "gift." This has fuelled debate concerning Starmer's acceptance of gifts, especially given his past pledge to abolish political corruption.

UK Prisons:

Justice Secretary Shabana Mahmood said at the Labour Party conference that a new "women's justice board" will be established in England and Wales to lower the female prison population and, ultimately, the number of women's jails. Mahmood criticised the previous government's stance on imprisonment, claiming that "for women, prison isn't working."

Faced with record jail overcrowding, the Labour government used emergency measures to release criminals early, and Mahmood emphasised the urgent need for reform in a system she described as a "breaking point." The new board will prioritise early interventions to divert women from the criminal justice system, strengthen community assistance, and address concerns unique to young women in custody.

Currently, women account for only a small proportion of the jail population, with many being nonviolent criminals and victims of domestic abuse. Mahmood emphasised that jails frequently aggravate criminal behaviour rather than rehabilitate inmates. The board will be led by a minister from the Ministry of Justice. The effort has been hailed as a significant step towards women's justice, with campaigners emphasising the importance of community alternatives and improved support services. Mahmood also pledged to enhance rape victims' access to legal assistance to lower trial dropout rates.

Geopolitics:

On the other hand, UK Foreign Secretary David Lammy has received criticism for referring to Azerbaijan's military action in Nagorno-Karabakh as a "liberation" in a Substack blog post. His statements came after Azerbaijan launched a military campaign in September 2023 to retake territory that had been under Armenian control since the early 1990s, resulting in the mass flight of over 100,000 Armenians who saw the region as their ancient homeland.

Critics accused Lammy of undermining UK foreign policy and supporting ethnic cleansing. The Foreign Office underlined that Lammy's remarks do not represent a shift in the UK government's position on Nagorno-Karabakh, which has long backed the territorial integrity of both Azerbaijan and Armenia.

Despite the controversy, Azerbaijan's envoy to the UK backed Lammy's remarks, claiming they were consistent with historical UK policy. The Foreign Office emphasised that it remains committed to promoting genuine conversation between the two countries to establish long-term peace in the region.

Sir Keir Starmer has downplayed the importance of long-range missiles in the context of the Ukraine conflict, emphasising that victory will require a more comprehensive strategic approach. As he prepares to attend the UN General Assembly, conversations with US officials about Ukraine's request to deploy Storm Shadow missiles in Russia are set to continue. Ukrainian President Volodymyr Zelenskyy is also in the United States to offer a "victory plan" to President Biden.

Starmer reaffirmed the UK's strong support for Ukraine, emphasising the military capabilities previously delivered and the intention to listen to Ukraine's requirements. He intends to address a wide range of topics in subsequent conversations rather than focusing simply on missile usage.

Meanwhile, President Putin has warned that permitting Ukraine to hit Russian territory with Western missiles would escalate the conflict, a statement supported by the Kremlin, which expressed that there would be serious consequences.

Tax:

The UK's decision to abolish the non-domicile tax regime by 2025 has prompted wealthy individuals to explore alternative fiscal havens across Europe. This shift began with the previous Conservative government's pledge and was confirmed by the new Labour administration. The non-dom status allowed UK tax residents with foreign domiciles to avoid UK tax on foreign income for 15 years, but this will be replaced with a residence-based system offering only four years of tax exemption for new residents.

Countries like Switzerland, Monaco, and Portugal are seeing increased interest from the wealthy. Switzerland's low income tax rates and lump-sum taxation attract many, although some can’t work under this system. Monaco remains appealing due to its lack of income tax, but high living costs are a deterrent.

Portugal is also attractive for its no inheritance tax and appealing lifestyle, although recent policy changes have limited its previous non-dom incentives. Its new government is expected to finalize regulations for a revised tax regime by the end of the year, but uncertainty remains.

Italy’s recent decision to double the flat tax on foreign income for ex-pats has raised concerns, yet its stable legislative framework continues to draw wealthy individuals. Greece’s tax regime offers a flat tax on foreign income and has attracted over 230 millionaires, but potential residents are wary about the sustainability of these favorable tax policies.

Labour market:

The Royal College of Nursing (RCN) reported that its members in England have rejected a planned 5.5% wage increase for 2024/25, which UK Chancellor Rachel Reeves had promoted as a big boost for public sector workers. This denial came shortly after Reeves justified her July decision to endorse above-inflation wage increases as a move towards better recruitment and retention.

The RCN indicated that members demand more significant action from the government and are dissatisfied with staffing numbers and compensation. The vote, in which two-thirds of participants rejected the offer, illustrates growing dissatisfaction among unions with Labour's economic policies. Many members believe the focus on public finances, especially cuts to retirees' winter fuel subsidies, is inappropriate.

Conclusion:

As the UK navigates a complicated economic landscape characterised by inflationary pressures, developing mortgage markets, and impending budgetary issues, the interplay of government policy, monetary strategy, and public opinion will be critical. The Bank of England's conservative approach to interest rates, along with the government's emphasis on public investment, indicate a cautious but strong push for long-term growth. With the next Budget, Labour's emphasis on infrastructure and green investment aims to address long-standing economic issues, while political and social elements complicate the overall fiscal picture. The decisions made in the coming months are likely to determine the UK's economic destiny for years to come.

Written by Sabina Rahman