The UK economy’s growth rate has been upgraded, but it falls short of Labour’s target

After the Bank of England lowered rates for the first in over four years, the pound and FTSE 100 both fell dramatically.

According to central bank forecasts, the economy is expected to grow much faster than originally thought this year, but the rate of growth over the long-term is still significantly lower than the target set by Labour’s new government.

The pound fell 0.77 percent against the US Dollar to $1.275. This is its lowest level in less than a month. The pound lost ground as well against the euro. It fell by 0.37 percent to €1.182.

The pound has been on a strong rise this year. This was partly due to the recent increase in political stability following Labour’s victory at the general elections and signs of a stronger economic growth. The pound sterling has been one the fastest-rising currencies among developed economies in 2024.

The Bank of England’s Monetary Policy Committee voted 5-4 to reduce the UK base interest rate from 5.25 percent to 5%.

Andrew Bailey, Governor of the Bank, has hinted that rates will not fall dramatically in the next few months. Analysts, however, questioned that assumption, causing the sterling to fall further.

James Smith, a Dutch economist who specializes in developed markets, said that the MPC would be surprised to see wages and inflation fall faster than expected. “This will make the committee feel more comfortable about making at least one additional cut this year.” We think the [cut] is most likely to come in November, and that it will be followed by a second in December.

Investors sold shares in Britain’s biggest listed banks, causing the FTSE 100 to fall by 1 percent, or 84.62 point. HSBC shares, NatWest shares, Lloyds Shares, and Barclays’ all fell by over 3.5 percent. The FTSE 250, which is more sensitive to domestic conditions, did not fare much better, dropping by 0.7 percent, or 141.48 point, to 21,459.23.

UK government bonds rose. The yield on two-year gilts fell by almost ten basis point to 3.715 percent, and the rate on ten-year government bonds dropped by about eight basis points.

The central bank has said that Britain’s gross national product will grow by 1.25 percent in 2024. This is a significant upgrade over its May projection of only 0.5 percent. Then, growth will slow to 1 percent in 2025 and then to 1.25 percent in 2026. Both of these were unchanged from the central bank’s expectations in May.

The Bank was among the most negative forecasters before the upgrade. Both the International Monetary Fund (IMF) and the Office for Budget Responsibility expected growth to be faster this year. The central bank’s forecasts are now in line with those of the majority.

The Bank’s average medium-term growth projection is a little over 1 percent, which is well below the target of Sir Keir starmer, who wants to achieve a 2.5%. The Prime Minister wants to make Britain’s economy the fastest growing in the G7.

In the King’s Speech the government announced several measures, such as reforming the planning system, and strengthening worker’s rights.

The Bank of England’s last policy meeting was held in June. Since then, data has shown that the demand from households and businesses is much higher than expected. The Office for National Statistics has recently revised upwards its estimates for GDP growth in the first quarter to 0.7 percent. This is the fastest rate of growth among the G7.

The Bank stated that “housing investment is expected grow modestly over the forecast period – stronger than the May report” and added that capital expenditure by businesses was also expected to drive GDP growth.

The Bank stated that the impact of external shocks, such as Russia’s invasion of Ukraine on the economy had diminished and was the main reason for the inflation falling to 2% over the past two month. The Bank said that the impact of past external shocks had abated, and there was progress made in reducing risks of inflation persistence.

The price growth will rise to 2.75 percent by the end the year, before reversing due to “the continued restrictive stance of the monetary policy” and the “emergence of an economic margin of slack”.

Tomasz Weiladek, Chief European Economist at T Rowe Price said that Tomasz’s prediction of a two-year-old inflation rate well below the Bank’s 2% target “implies the Bank will have to reduce rates more than the current market prices”. The Bank is expected to cut rates twice more this year, according to traders.

Slow unwindings of second-round effects, exemplified typically by high wage growth, pose a long-term risk to the price pressures embedding themselves in the economy. Four members of the MPC voted to maintain interest rates because this dynamic was so important.

The robust economy will keep unemployment at the current level of 4.4% for the remainder of the year. The Bank predicts that unemployment will reach a low of 4.8 percent in 2026.

The Bank stated that it is difficult to accurately capture the dynamics of the workforce due to concerns about accuracy in the ONS monthly labour force surveys.

The assumption of stronger growth is supported by a rapid recovery in the living standards of households from the crisis caused by rising costs. The real post-tax income of labour is expected to grow by 3.5% this year, and by 1.5% in 2025. This will fuel household spending.