The Bank of England’s May forecast for pay growth proved overly optimistic, prompting a likely course correction with an anticipated interest rate cut this Thursday. A quarter-point reduction to 4% is widely expected, marking the fifth cut since last August, driven by concerns over rising unemployment and the economic impact of Donald Trump’s fresh round of import tariffs. Financial markets are pricing in an over 80% chance of this August rate reduction.
The Chancellor, Rachel Reeves, is expected to welcome the lower mortgage rates and reduced borrowing costs for businesses that this cut would bring, offering some immediate financial respite. However, the broader economic context highlights a difficult situation for the UK government, which is struggling to boost growth while trying to limit Whitehall spending. The economy shrank in May by 0.1% and in April by 0.3%, a contraction largely attributed by economists to the uncertainty caused by Trump’s tariffs and extra business taxes.
The latest labor market data further underscores the economic fragility, with job vacancies falling below pre-pandemic levels and the unemployment rate climbing to 4.7% in the three months to May, the highest level since June 2021. The cooling of pay growth, faster than previously predicted, provides additional justification for a rate cut.
Despite a previously signed trade deal with the UK, President Trump’s recent announcement of additional import tariffs of up to 50% on other trading partners is set to harm global growth, with inevitable repercussions for the UK. The International Monetary Fund (IMF) recently tempered its outlook for the UK economy, predicting only modest expansion for the remainder of the year. The MPC’s fresh forecasts on Thursday could paint an even bleaker picture, indicating an imminent period of stagflation, marked by a slowdown in growth and stubbornly high inflation, currently at 3.6% CPI.