The Bank of England has warned Kwasi Kwarteng that the economy is in recession and will likely have to raise interest rates after Friday’s tax cut mini-budget.
On the eve of a major support package from the chancellor designed to break what it called the economy’s “cycle of stagnation”, Threadneedle Street said the UK economy was heading for a second consecutive quarter of fall in production, with gross domestic product on the verge of shrinking. 0.1% in the three months to September.
However, with energy and food bills still rising, and inflation not expected to peak until October, the Bank of England raised the cost of borrowing for a seventh meeting consecutive chair of its monetary policy committee (MPC) and made clear that the new government’s plans risked further interest rate hikes.
The MPC, which raised interest rates by 0.5 percentage points to 2.25% on Thursday, said it would carefully assess the impact of energy price caps and the government’s growth plan before of the committee’s next decision in November.
In a letter to the chancellor explaining why inflation is running at almost five times its 2% target, Bank governor Andrew Bailey said: “Should the outlook suggest more persistent inflationary pressures, including higher demand force, the committee will respond forcefully, as necessary.”
Kwarteng will announce 30 separate measures on Friday, including tax cuts, new investment zones and an acceleration of infrastructure projects, in an effort to boost the economy’s growth rate to its stated target of 2.5% a year .
One of the main elements of the package – the £13bn reversal of the rise in National Insurance contributions, introduced in April to fund the health and social care tax – will come into effect on November 6, three days after the next Bank interest rate. decision
While almost 28 million people will keep more of their income as a result of the move, the Resolution Foundation think tank said that on average the poorest 10% of households would earn £11.41 in 2022 -23, while the richest 10% of households would earn £682.
The mini-budget is expected to contain significant additional interventions to boost growth beyond investment from the rise in CIT and the expected rise in corporation tax for next April, sources in the Treasury, with a Whitehall source describing the package as “more rabbits than Watership Down”. “.
A key focus of the fiscal event will be new investment zones for 38 local and mayoral authorities in England, including the West Midlands, Tees Valley, Somerset and Hull, which will see significant planning deregulation to free up more land for housing and commercial development, and taxes. cuts for companies.
The plans for the investment zone include a number of controversial measures such as removing the need for developers to meet affordable housing targets, as first revealed by The Guardian. Environmental regulations will also be reduced in these areas.
Kwarteng will defend plans to lift the cap on bankers’ bonuses and ban fracking, saying the government will be “bold and unashamed in pursuing growth, even when it means making tough decisions”.
He will also announce measures to speed up the delivery of around 100 major infrastructure projects across the country which he will say have been unnecessarily delayed by red tape.
The chancellor will tell MPs: “Growth is not as high as it should be, which has made it harder to pay for public services, forcing taxes to rise. This cycle of stagnation has meant that the tax burden is forecast to reach the highest levels since the late 1940s.
“We are determined to break this cycle. We need a new approach for a new era focused on growth. This is how we will deliver higher wages, more opportunities and enough revenue to fund our public services, now and in the future.
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“This is how we will successfully compete with dynamic economies around the world. This is how we will turn the vicious cycle of stagnation into a virtuous cycle of growth.”
Pat McFadden, the shadow chief secretary to the Treasury, said the sums involved were extraordinary with no examination of how they would be funded other than through borrowing.
“His choice to finance all of this through borrowing and not try to finance even a part of it through a windfall tax on energy companies making the most of the current crisis increases the risk and makes British taxpayers pay more for longer,” he said.
Announcing its latest interest rate decision, the Bank of England said the energy price guarantee, which caps household bills, would mean inflation would peak below 11% this fall instead of over 13%. Although the consumer price index fell slightly from 10.1% in July to 9.9% in August, it remains at a level not seen since the early 1980s.
However, Bailey said in his letter to Kwarteng that the government’s support measures risked increasing pressure on the cost of living. “All else being equal … this will increase inflationary pressures over the medium term,” Bailey wrote.
After a 0.1% fall in GDP in the three months to June, the Bank said a further 0.1% fall could now be expected in the third quarter amid a fall in spending in consumption and weaker activity for manufacturing and construction.
He said the drop also reflected a smaller-than-expected uptick from extra bank holidays for the Queen’s Platinum Jubilee, as well as the impact of businesses closing their doors in respect for the funeral of state this week. An economy is technically in recession if it experiences two consecutive quarters of negative growth.
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: “The opening whistle has been blown by the economic tug-of-war between the Bank of England and Liz Truss’s government .
“Team Bailey at the Bank of England wants to squeeze demand out of the economy, to try to stop the price spiral, while Team Truss wants to stimulate it, risking prolonging the pace of rate hikes type”.