Bank of England Predicts Inflation Drop from Reeves’s Budget

The Bank of England anticipates that Chancellor Rachel Reeves’s recently announced budget will reduce the UK’s headline inflation rate by as much as half a percentage point next year. This projection, delivered by Clare Lombardelli, a deputy governor at the Bank, suggests that the central bank’s initial analysis indicates an annual reduction of between 0.4 and 0.5 percentage points starting from mid-2026.

Reeves’s budget centers on cutting inflation and includes a comprehensive £26 billion package of tax increases aimed at addressing a public finance shortfall and discontinuing the two-child benefit policy. Key measures designed to alleviate the cost of living include the removal of green subsidies from household energy bills and a freeze on rail fares. The chancellor has indicated that levies on energy bills will now be funded through general taxation, potentially lowering energy costs for households by an average of £150 annually starting next April.

Impact of Budget Measures on Inflation

The Bank’s early assessment aligns with predictions from the Office for Budget Responsibility released alongside Reeves’s budget statement. It attributes the majority of the projected inflation reduction to the budget’s energy-related measures, as well as the chancellor’s decision to freeze fuel duty for motorists. With the Bank of England’s monetary policy committee (MPC) set to meet next Thursday, financial markets expect a reduction in borrowing costs, which would lower interest rates to 3.75%, down from the current 4%. This would mark the sixth interest rate cut since the peak of 5.25% in mid-2022.

Lombardelli emphasized the importance of considering Reeves’s budget policies in the central bank’s future decisions, although she cautioned that longer-term inflation outlooks must also be taken into account. While the immediate effects of the budget may positively influence headline inflation, other government initiatives, such as rising living wage costs and enhanced workers’ rights, could exert upward pressure on prices in the future.

“This is new information the committee will consider,” Lombardelli stated, adding, “[We need to consider] how much are you affected by one-off, one-year short-term impact of inflation.” She noted that opinions within the MPC may vary regarding the potential balance between short-term relief and long-term inflationary impacts.

Future Inflation Prospects and Economic Context

The chancellor’s initiatives aim to mitigate household bills, yet additional costs are anticipated due to recent approvals by Ofgem for £28 billion in spending related to Great Britain’s gas and electricity infrastructure. Headline inflation has decreased from a peak of over 11% in late 2022 but has begun to increase again this year, driven by rising food prices, energy costs, and utility bills. Businesses are reportedly passing on the impact of tax increases to consumers.

Despite a drop to 3.6% in October 2023, the current inflation rate remains above the Bank’s target of 2%. The Bank of England has previously indicated that it expects inflation to have peaked at 3.8% during the summer and suggested that it could decline to approximately 2.5% in the coming year.

As the economic landscape continues to evolve, the forthcoming decisions from the Bank of England will be closely monitored for their potential impact on inflation and the broader UK economy.