Rachel Reeves has been given an inflation warning by the Bank of England as it cut interest rates to the lowest in two years but forecast months of sharp cost rises driven by higher food prices.
There was relief for borrowers as interest rates were cut to four per cent.
But the bank said headline inflation would accelerate to four per cent in September, while inflation on food will hit 5.5 per cent between now and Christmas – putting a squeeze on household budgets.
As a result the bank’s governor, Andrew Bailey, signalled that interest rates would fall more slowly in coming months, saying they were “still on a downward path” but changes would have to be “made gradually and carefully”.
Amid fears the rate cut could stoke inflation, the committee that made the decision was split and was forced to take a second vote for the first time in its history to break the deadlock.
The forecasts pile more pressure on the chancellor, less than 24 hours after Sir Keir Starmer pledged that this autumn’s budget will make “sure people feel better off”.
Ms Reeves welcomed the rate cut, saying it would help “bring down the cost of mortgages and loans for families and businesses”.
But she also left the door open to tax hikes in the Budget, after leading economists said she may have to raise levies, cut public spending or tear up her fiscal rules to fill a multi-billion black hole.
She also came under pressure from former Labour prime minister Gordon Brown who suggested increasing gambling taxes to fund the abolition of the two-child benefit cap and taking defence spending out of her borrowing rules to free up economic ‘headroom’.
But the Tories said the NI rise “and reckless borrowing have pushed inflation well above target”.
Alongside the announcement on a cut in interest rates, the Bank of England said the chancellor’s £25 billion national insurance raid has pushed up food prices.
Higher wage costs are contributing to food inflation, partly because of increases in minimum wages and the impact of the increase in National Insurance Contributions (Nics).
A “relatively high proportion of staff” in food manufacturing and retail are paid at or close to the national living wage, which increased by 6.7% in April.
“Furthermore, overall labour costs of supermarkets are likely to have been disproportionately affected by the lower threshold at which employers start paying Nics, in part because a relatively high proportion of supermarket staff is employed part-time,” the report said.
Most of the wage costs and part of the Nics rise have been passed on to consumers putting up prices by about 1 to 2 per cent, with customers facing further hikes later this year.
The controversial Nics move has also “weighed on growth”, according to businesses, the bank’s latest monetary policy report said.
Business chiefs also expressed concerns to the bank about other government policies, including Deputy Prime Minister Angela Rayner’s Employment Rights Bill.
Helen Dickinson, chief executive at the British Retail Consortium, said: “Government policy will add £7bn to retailer costs this year, from higher employment costs to the introduction of a new packaging tax.
“Food prices have already been climbing steadily, and the BRC has warned this is only the beginning.
“If the autumn budget once again lands on the shoulders of retailers, then it will only serve to fan the flames of food inflation, with poorer families being hit the hardest by the Treasury’s decisions.”
James Smith, from the Resolution Foundation economic think tank, said: “There was bad news for the chancellor from the Bank of England today as its forecasts remain more pessimistic on growth than the Office for Budget Responsibility, suggesting bad news is coming at the autumn budget.
“Bank rate is now 4 per cent – its lowest level since March 2023. While this will be broadly welcomed by mortgagors, around 700,000 families will still see repayments rise as they come off five-year fixed-rate deals.
“There was also bad news from the Bank of England for families struggling with the cost of living: inflation is set to be higher than previously expected, with food inflation rising further in the coming months, and real wage growth set to hit a brick wall this year.”
