The pound dropped to a three-week low after the governor of the Bank of England said it could make bigger cuts to interest rates if the job market slows too quickly.
Andrew Bailey said “slack” was opening up in the UK economy, as higher taxes have squeezed employers.
He told the Times: “I really do believe the path is downward” for interest rates. The bank rate stands at 4.25%, after four quarter-point cuts in the last year, and the Bank is next scheduled to make another decision on 7 August.
Bailey said: “If we saw the slack opening up much more quickly, that would lead us to a different conclusion.
“I think the path [for interest rates] is down. I really do believe the path is downward but we continue to use the words ‘gradual and careful’ because … some people say to me: ‘Why are you cutting when inflation’s above target?’”
Inflation in the UK eased slightly to 3.4% in May, from 3.5% in April, still significantly above the Bank’s 2% target.
On Monday morning, the pound slipped 0.2% after Bailey’s remarks, down to $1.3467 – the lowest level since 23 June. It recovered slightly over the course of the day, trading down 0.18% at $1.3474 in the afternoon.
Investors also raised their expectations that there would be a rate cut in August, with money markets indicating an 85% chance of a cut, up from 76% at the end of last week.
The head of the central bank noted Rachel Reeves’s decision to increase taxes on employers, saying companies were “adjusting employment and hours and also having pay rises that are possibly less than they would have been if the [national insurance contributions] change hadn’t happened”.
The chancellor hit businesses with a £25bn rise in employer national insurance contributions, introduced in April, as well as a 6.7% rise in the national living wage.
Bailey’s suggestion that lower rates and reduced inflation could be on the horizon comes as the government faces pressure to improve living standards.
Last week official data showed the economy unexpectedly shrank by 0.1% in May, fuelled by sharp declines in manufacturing and construction. It marked the second month in a row that the economy weakened, after a 0.3% drop in GDP in April.
Reeves’s tax and spending plans have been constrained by borrowing costs and downgraded growth forecasts. The chancellor increased taxes by a historic £40bn in her budget last October but critics have argued that her strict fiscal rules give her little headroom.
Her £10bn margin was poised to be wiped out before the spring statement in March, prompting a scramble for savings that led to the £5bn cuts to disability benefits, which Labour largely dropped after a backbench revolt.
The chancellor is now widely expected to increase taxes in her autumn budget to close the gap created by U-turns on disability benefits and the winter fuel allowance, as well as weak economic forecasts.
Bailey’s remarks also came as the consultancy KPMG found that hiring by UK businesses dropped by the fastest pace in almost two years.
The Recruitment and Employment Confederation trade body and KPMG said their index of staff availability rose to 66.1 from 63.3 in May, the highest reading since November 2020.
