The Bank of England will be forced to cut interest rates at a “gradual” pace as it evaluates the impact of the chancellor’s decision to raise taxes on employers, governor Andrew Bailey has warned.
Bailey told members of the Treasury select committee that there could be a variety of outcomes resulting from the £25bn increase in employer national insurance contributions (NICs) and the rise in the minimum wage, set to come into effect in April.
These could include higher inflation if businesses raise prices, lower wage growth, reduced employment, squeezed profit margins, or a boost in productivity.
“There are different ways in which the increase in employer national insurance contributions announced in the autumn budget could play out in the economy,” Bailey told MPs.
He added: “A gradual approach to removing monetary policy restraint will help us to observe how this plays out, along with other risks to the inflation outlook.”
Bailey also warned that services inflation remains at odds with the BoE’s 2% inflation target.
Catherine Mann, a fellow policymaker and the only member of the monetary policy committee (MPC) to vote against cutting interest rates last week, expressed concerns about prolonged inflation.
She said her assessment of the budget took into account two key aspects: that it was “front-loaded on demand” and “geographically dispersed”. This, she argued, would provide companies with opportunities to “realise” price increases.
Bailey also noted that the budget had driven up mortgage costs, particularly following chancellor Reeves’ announcement of £70bn in annual spending increases over the next five years. He agreed with concerns raised by retailers, who have warned of potential job cuts due to the tax hikes.
“I saw the BRC’s [British Retail Consortium] letter and I think they’re right to say, I think there is a risk here that the reduction in employment could be more. Yes, I think that’s a risk,” Bailey said.
The governor also acknowledged that companies would initially face greater pressure on their margins from the tax hikes, but this pressure should ease over time. “Probably, initially, there will be more pressure on firms’ margins because it takes them longer to adjust and then they’ll probably rebuild those profit margins over time. I would expect that,” he said.
Read more: Eurozone inflation returns to target rate of 2%