BOE's Inflation Fight Could Be Extended by UK Budget

The UK's 2024 Budget, announced by the Chancellor, has set out a significant increase in public investment and spending, which could extend the Bank of England's (BOE) inflation fight. The Budget includes a £100 billion boost to public investment over the next five years, focusing on infrastructure projects such as roads, rail, schools, and hospitals. Additionally, day-to-day spending for public services is set to grow by an average of 3.3% in real terms between 2023-24 and 2025-26, with a £22 billion increase for the health sector to tackle waiting lists.


This substantial fiscal stimulus could put upward pressure on inflation, as increased demand for labor and materials drives up wages and prices. In his July 2021 speech, Michael Saunders, a member of the BOE's Monetary Policy Committee, acknowledged the potential risks to inflation from strong global demand for goods and services, as well as the possibility of persistent effects on UK CPI inflation. The BOE may need to maintain or even tighten monetary policy to counter these pressures, potentially extending its inflation fight.


The BOE's inflation target is 2%, and with the output gap closing earlier than expected, it may need to act to prevent inflation from overshooting. In his speech, Saunders suggested that if activity and inflation indicators remain in line with recent trends, the BOE could curtail its asset purchase program and consider further policy action. The BOE's challenge will be to manage inflation expectations and ensure that the benefits of increased investment outweigh the short-term costs to export competitiveness.

The UK Budget's tax changes, particularly the increase in corporation tax from 19% to 25% for businesses with profits over £250,000, may initially dampen business investment. However, the significant public investment boost could offset some of the negative impact on investment. In terms of inflation, the tax increase may put upward pressure on prices, as businesses pass on higher costs to consumers. The Office for Budget Responsibility (OBR) projects that the impact on inflation will be modest, with CPI inflation expected to peak at 4% in the fourth quarter of 2021 before returning to the 2% target.

The BOE's forward guidance on interest rates could be influenced by the UK Budget's spending and tax measures. The increased public investment and spending could stimulate economic growth and potentially boost inflation. If the BOE perceives these fiscal measures as contributing to a more sustained period of higher inflation, it may adjust its forward guidance on interest rates to manage inflation expectations and prevent a potential overshoot of the 2% target.

In conclusion, the UK's 2024 Budget, with its substantial increase in public investment and spending, could extend the BOE's inflation fight. The BOE may need to maintain or even tighten monetary policy to counter these pressures, potentially leading to higher interest rates and borrowing costs. The Budget's mix of tax changes and public investment should help manage inflation dynamics, but the BOE's challenge will be to balance the benefits of increased investment with the risks of higher inflation and its impact on export competitiveness.