UK long-term borrowing costs have edged down from the recent highs, offering some reprieve for the Chancellor. But gilt yields are still higher than in the run up to the Autumn budget. With real GDP stagnating, worsening growth prospects mean that Rachel Reeves’ fiscal headroom is dwindling. The PSNB ex is widening again, hitting £139.9bn in the twelve months to December, with current expenditures up 6.0% y/y (6-month moving average).
The BoE cut bank rate by 25 bps to 4.5% last week, after it revised its growth forecast down, but revised up its inflation forecast. CPI inflation is projected to rise further in the near term, reaching 3.7% in 2025 Q3, mainly driven by higher energy prices. Expectations for food price inflation have also increased, however. Inflation expectations jumped following the budget, according to several surveys.
Without a significant improvement in the supply side of the economy, inflationary tendencies in the economy will persist: labour productivity contracted 1.8% y/y in Q3. It is becoming less credible for central banks to justify ‘looking through’ so-called ‘transitory’ price increases when they occur with increased frequency, and when growth in the supply capacity of the economy has also weakened. Some BoE policymakers are striking a dovish tone, but gilts will struggle to outperform in a stagflationary environment, particularly with ongoing fiscal largesse.
