The Bank of England’s Cost Caveat

Early analysis released by the Bank of England yesterday shows that the Chancellor’s budget may deliver a temporary but material disinflationary impulse next year.

Deputy Governor Clare Lombardelli told MPs that Budget measures to cap transport and energy costs could reduce annual inflation by 0.4-0.5 percentage points for a year from Q2 2026. Markets have interpreted this as clearing the path for a December rate cut, though the MPC remains deeply split ahead of its vote, with the full inflation assessment not due until February.

The same report also put the UK’s labour market in the firing line. Catherine Mann told MPs yesterday that Reeves’s decision to implement a £26bn National Insurance rise and a higher minimum wage has forced many firms to curtail recruitment. BOE survey data shows that roughly half of businesses report needing to reduce headcount as a result. Mann described firms as “digesting these costs” through narrower margins, automation or, in many cases, job cuts – an adjustment she likened to a “pig in the python.”

Reeves rejected such suggestions that her tax measures are linked to job losses, pointing to an increase of 329,000 jobs this year. However, since Labour took office in mid-2024, the unemployment rate has risen from 4.3% to 5% (the highest level since the 2021 covid spike), and forecasts imply this trend could extend into 2026.

The UK now has one of the highest minimum wages globally, set to rise to £12.71 per hour in April, up 43% since 2021. Evidence from hiring platform Indeed indicates that lower-paid roles have contracted meaningfully, with UK hiring for low-wage jobs down 20% relative to pre-Covid levels. In contrast, Italy, France and Germany have all seen increases, a divergence largely attributed to wage and tax policy.

Both Lombardelli and Mann acknowledged these risks. Lombardelli was explicit that she sees more upside risk to inflation than some colleagues and is less convinced that monetary policy is as restrictive as commonly assumed. Mann, meanwhile, affirmed that faster-than-expected labour-market deterioration could soften her inflation concerns but warned that behavioural changes, households adapting to prolonged price instability, may yet entrench stickier inflation than headline numbers imply.

For the MPC, this presents a familiar policy paradox: falling inflation on one side, a softening labour market on the other. With the definitive inflation data not due until February, policymakers are operating on partial information just as fiscal policy and labour-cost pressures begin to converge.

As it stands, the markets expect a 91% chance of a cut, but the BoE rate split may prove more finely divided.