Inflation fears and stagnation stalk Reeves before UK budget
[LONDON] Fresh economic data delivered twin blows to British Chancellor of the Exchequer Rachel Reeves ahead of her crucial autumn budget, showing both growth stagnating and households’ inflation worries mounting.
The Bank of England (BOE) said inflation expectations jumped to the highest level in two years in a setback to both the central bank and the chancellor, who businesses blame for fanning prices with tax increases.
Reeves is trying to draw up fiscal plans that will turbocharge a tepid UK economy at the same time as helping the central bank in its battle against inflation. Interest-rate cuts that would provide some relief to households are being held back by price pressures that are once again worse than in many other advanced economies.
Hopes of more reductions to borrowing costs this year were dampened further by signs of mounting inflation worries among consumers. The BOE’s quarterly survey on Friday (Sep 12) found households expect prices to rise 3.6 per cent over the next 12 months, up sharply from 3.2 per cent in May and the highest since August 2023. In the longer term, they predicted inflation of 3.8 per cent in five years’ time – the highest reading since 2019.
Earlier on Friday, official data showed gross domestic product flatlining in July, marking a weak start to the third quarter amid pressure on business and consumers from higher taxes. While the UK was the best performing economy among the Group of Seven countries in the first half of 2025, a weaker pace is expected in the second half and the BOE believes the underlying growth rate is subdued.
It leaves Reeves with a difficult balancing act at the budget on Nov 26 as she tries to find money for public services without a blitz of tax increases that threaten to dampen growth and stoke price pressures. The UK’s abysmal productivity performance also means the economy risks generating inflation with even anemic growth.
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Businesses have warned against more big tax rises as the chancellor casts around for ways to plug a fresh multibillion-pound hole in her fiscal plans. Reeves has acknowledged the government “must focus on going further to support the BOE in reducing inflation, controlling public spending and driving growth”.
Households’ concerns over inflation have mounted after price growth accelerated to an 18-month high of 3.8 per cent, almost double the BOE’s 2 per cent target.
While global commodity prices play a role, the surge is largely being fuelled by domestic factors, including food bills as businesses pass on higher costs from the £26 billion (S$45.2 billion) hike in payroll taxes and an increase in the minimum wage – changes that took effect in April.
Several BOE rate-setters have grown anxious about rising inflation expectations, putting more rate cuts later this year in serious doubt. Research suggests that households start to respond to price pressures when inflation rises towards 4 per cent, with food bills a particular concern given its salience for consumers.
“Household inflation expectations are modestly de-anchored on the Bank of England’s survey measure, which warrants caution from the (Monetary Policy Committee) in lowering interest rates further,” said Robert Wood, chief UK economist at Pantheon Macroeconomics. “Inflation running nearly double the target and households expecting that to continue poses a trickier backdrop for the crucial pay settlements period later this year than we saw in 2024.”
It means households expect inflation to remain above the 2 per cent target for years to come, which the BOE fears could fuel worker demands for higher pay to compensate with knock-on effects on prices.
The figures will deepen concerns that policymakers are losing control of public perceptions following a fresh price spike that’s expected to see inflation hit 4 per cent in September on the back of surging food bills.
Governor Andrew Bailey recently played down the rise in short-term expectations, saying it is to be expected given the rise in inflation. However, his deputy Clare Lombardelli and other more hawkish rate-setters have flagged worries over how food prices are being noticed by consumers. BLOOMBERG
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