(Bloomberg) -- Prime Minister Keir Starmer’s ambition to lift UK economic growth to 2.5% a year is expected to be dealt a blow when the Bank of England releases new forecasts next week.
In its economic update on Aug. 1, the BOE will say the UK’s long-term growth potential is less than 2%, economists predict, leaving Chancellor of the Exchequer Rachel Reeves with tough decisions if she is to deliver big pay rises for public-sector workers and make a start on fixing the country’s dilapidated public services.
Labour’s plans to boost the minimum wage and public-sector pay also threaten to slow the pace of interest-rate cuts that are needed to lift the economy, three economists said.
Labour campaigned in the general election on a platform of “iron clad” fiscal discipline, limited tax rises and better public services. The International Monetary Fund calculates that the economy will need to grow at 2.6% a year to meet all three ambitions, a figure first reported by the Financial Times.
The UK has come out of last year’s recession more strongly than anticipated, but the BOE is expected to deliver only a modest upgrade to its May projections of 0.4% growth in 2024 and 1% in 2025. Economists polled by Bloomberg forecast 0.8% growth this year and 1.3% next. They expect the bank’s estimate of the long-term sustainable UK growth rate will be unchanged at 1.75%.
“The BOE will almost certainly raise its growth forecast based on a better immediate outlook but there is very little chance it will raise its forecast so substantially that the government gets what it desires,” said George Buckley, chief European economist at Nomura.
Hetal Mehta, head of economic research at St James’s Place, said the shortfall in long-term growth will mean that “to meet its spending priorities, the government will need to raise revenues. So there is a good chance they will raise wealth taxes.”
Reeves has pledged not to increase VAT, national insurance, income or corporation taxes – which together account for two-thirds of government receipts.
Over the weekend, she hinted that she was prepared to boost spending by granting above-inflation pay rises to teachers and National Health Service staff amid reports that the official pay review bodies have suggested increases of 5.5% - over the 3% budgeted. The Institute for Fiscal Studies has said it could cost an extra £10 billion if applied across the whole public sector.
Those pay rises, alongside Labour plans for a more generous and expanded minimum wage for all workers over the age of 18, also pose a risk to inflation and delay the rate cuts that are needed for faster growth.
Mehta said: “Both will be slight headwinds in the fight against inflation and temper the pace of rate cuts, and probably the terminal rate as well.” Buckley agreed that the pay rises “would be inflationary.”
Ashley Webb, UK economist at Capital Economics, said about public-sector pay: “If the government chooses to extend this pay rise to all public-sector workers, it would probably support domestic inflation by a bit more than we expect. That may mean interest rates are cut slower and by less than we anticipate.”
The BOE’s Monetary Policy Report will be released just days after Reeves publishes a Treasury-led review of the fiscal position and spending inheritance left by the previous Conservative government. The review may be used to make the case for emergency tax rises.
She will announce the budget date alongside the review. If the Office for Budget Responsibility is to be given the full 10 weeks to prepare a forecast, it will be held no sooner than early October.
(Updates with comments from Capital Economics)
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