The UK’s economic recovery will accelerate over the next 12 months, forcing the Bank of England to keep interest rates higher for longer, according to the National Institute of Economic and Social Research (NIESR).
The think tank suggested views of further rate cuts before the end of the year may be wrong, saying a gradual economic recovery and the threat of persistent inflationary trends should make the central bank more cautious about lowering borrowing costs.
Neesl said he expects interest rates to gradually fall from 5% over the next 12 months to 4.6% in 2025, 4.1% in 2026 and reach 3.1% in 2028. That’s significantly higher than the 0.75% rate the bank set in 2019, before the coronavirus pandemic.
The cost of mortgages and business loans is expected to rise, leaving many homeowners with higher monthly interest payments, businesses are expected to go bankrupt and unemployment is expected to rise.
Neiser said UK growth would fall to 1.2% for the remainder of the forecast period, from 2026 to 2029, due to a lack of business investment and expected productivity growth.
Bank regulators cut interest rates to 5% from 5.25% earlier this month. They expect Britain’s growth rate to be slower than Neiser’s forecast, and the central bank is set to cut rates at least one more time this year and steadily through to 2025.
Chancellor of the Exchequer Rachel Reeves has pledged to lift UK growth to 2.5%.
Jagjit Chadha, director of Nieser, said Reeves needed to raise Britain’s growth rate without increasing inflation, which meant increasing long-term public investment in education, health, transport and energy.
He said the “dogma” of budget rules prevented the Treasury from approving long-term investments that would cost billions of pounds up front but boost national income, or gross domestic product, in the long run.
Referring to recent riots across the UK, Chadha said the “best way” to raise GDP was to tackle productivity and increase the incomes of the lowest paid in society. He said this would require increased public sector spending, increased productivity and “a lot of patience on behalf of an increasingly divided public”.
Following growing calls from economic think tanks for the Chancellor to increase investment spending in the Budget, Neiser said Reeves should “be brave” and rewrite the budget rules to link day-to-day spending with long-term public investment.
Mr Reeves has pledged to keep two rules in place before the budget is presented on October 1. The first requires the government to reduce its debt as a percentage of national income in the fifth year of any five-year projection period.
The UK’s debt-to-GDP ratio is 97%. The second rule requires the Treasury to limit the spending deficit to 3% in the final year of the forecast.
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The Institute for Fiscal Studies, a tax and spending think tank, said changing how debt is measured would allow the government to borrow billions of dollars but would not change “fiscal realities”.
Ben Zaranko, senior research economist at the IFS, said changing the debt rules could be an “attractive” option for Mr Reeves, who blames the previous government for leaving behind £22 billion of unfunded debt.
Reeves said the costs he inherited when he took office included around £10 billion in civil servant salaries and £6.4 billion for housing refugees.
But the think tank said the technical change in the definition did not change “fiscal reality”, with Zaranko warning the government “not to get too caught up in technical debt definitions”.
Global factors could also be crucial in determining how fast the UK will grow. Kneesl said that while most countries are expected to continue recovering from the coronavirus pandemic and the cost of living crisis, a US recession and conflict in the Middle East pose risks to the global growth outlook.
The think tank said it expects the global economy to slow to 3 percent from 4 percent over the next 12 months.
