Investors bet UK interest rates could start falling by March, as borrowing lifted by record debt servicing costs

Investors bet on Bank of England interest rate cuts early next year

UK interest rates could start to be cut as early as March, some City investors believe, after Wednesday’s welcome drop in inflation.

The money markets are pricing in a sharp fall in UK borrowing costs, after the UK inflation rate dropped to 3.9% in November, a bigger fall than expected.

Bank rate is currently 5.25%, a 15-year high. Investors now see a 40% chance that rates will be cut in March 2024, to 5%, with a cut by May 2024 now priced in.

UK interest rates are seen falling below 4% by the end of 2024, with the money markets now pricing in almost 1.4 percentage points over the course of next year.

Following this morning’s lower-than-expected UK inflation data, investors are now betting on almost 1.25 percentage points worth of rate cuts next year, taking the @bankofengland rate down to 4 per cent by the end of the year. pic.twitter.com/jvcCfpxC5n

— Ed Conway (@EdConwaySky) December 20, 2023

The drop in inflation is putting pressure on the Bank of England to rethink its position that it’s too early to consider cutting interest rates.

Having been criticised for not reacting quicker to the inflationary upsurge in 2021, critics now warn the BoE could be too tardy in responding to the drop in inflation in recent months.

Sanjay Raja, Deutsche Bank’s chief UK economist, called yesterday’s inflation report a welcome Christmas surprise, adding that it:

….raises further downside risks to the Bank of England’s inflation projections – raising the likelihood of a more dovish pivot in February.

Key events

So far this financial year (since April), the UK central government has received £618.1bn in taxes and other payments, an increase of £26.3bn compared with the same period a year ago.

But, that is exceeded by a £70.8bn increase in total expenditure, which rose to £754.9bn over the same period (requiring more borrowing to cover the gap).

This additional spending included increases in:

net investment of £40.1bn, of which £32.4bn was an increase in payments to the Bank of England’s Asset Purchase Facility (which has been selling bonds bought through its QE programme, at a loss).
inflation-linked uprated benefits and cost-of-living payments of £21.6bn
spending on goods and services (largely pay and procurement) of £22.4bn
grants to local government of £5.1bn (these reduce local government borrowing)

Interest payable on central government debt hits £7.7bn, a November record

The cost of servicing the UK’s national debt hit a record high for a November last month, helping to push up monthly borrowing to over £14bn.

Debt interest payments last month rose to £7.7bn, the ONS reports in this morning’s public finances (see earlier post).

That surpasses all monthly November figures on record since 1997, but is slightly lower than October’s £8.1bn interest bill.

The cost was driven up by inflation, as the interest rate on some UK debt is linked to inflation – specifically the Retail Prices Index.

A chart showing UK government interest payments on the national debt — Photograph: ONS

Divya Sridhar, economist at PwC UK, explains:

“High debt interest payments reflect the fiscal implications of swings in the Retail Prices Index (RPI). The latest inflation data released yesterday brings a welcome surprise as headline annual inflation fell faster than expected to 3.9% last month.

Due to lagged index-linked gilts, the fiscal benefits of this fall in inflation rates will be reflected in borrowing figures early next year.

Chief Secretary to the Treasury, Laura Trott, has responded to November’s UK borrowing figures, saying:

“It was right to spend billions protecting people during the pandemic and the energy shock triggered by Putin’s invasion of Ukraine, but we cannot leave our children and grandchildren to pick up the tab.

“That’s why the Prime Minister has made reducing debt a top priority. We are taking difficult decisions in the national interest to control our borrowing needs and improve productivity, so that we deliver the public services people need while keeping inflation down.”

Earlier this week, Rishi Sunak was criticised by the UK’s statistics watchdog over his claims to have reduced public debt.

Under the latest forecasts from the independent Office of Budget Responsibility, UK borrowing is forecast to fall from 5.0% of GDP this year to 1.1% of GDP by 2028-29.

Photograph: OBR

That would mean debt would fall, as a share of GDP, in 2027-28 and 2028-29.

UK borrowed £14.3bn in November, more than expected

The UK government borrowed more than expected last month, which may dampen the mood in the Treasury after Wednesday’s drop in inflation.

Public sector net borrowing (excluding the impact of public sector banks) has just come in at £14.3bn.

That’s the fourth highest November borrowing since monthly records began in 1993, and higher than the £12.9bn which economists forecast.

But it is a little lower (-£900m) than in November 2022, when the government was funding support programmes to lower energy bills.

Subsidies paid by central government were £2.2bn in November 2023, £3.1bn less than a year ago, the Office for National Statistics says.

Public sector net borrowing excluding public sector banks was £14.3 billion in November 2023, £0.9 billion less than in November 2022.

It was the fourth highest November borrowing since monthly records began in 1993.

➡️ https://t.co/sFp3aWgVpt pic.twitter.com/sMG33hqrOB

— Office for National Statistics (ONS) (@ONS) December 21, 2023

So far this financial year (since April), the UK has borrowed £116.4bn. That’s £24.4bn more than in the same eight-month period last year and the second highest financial year-to-November borrowing on record.

November’s borrowing means the UK national debt is now estimated at around 97.5% of UK GDP, at £2,671.4bn.

That’s 1.8 percentage points higher than in November 2022, the highest since the early 1960s.

Investors bet on Bank of England interest rate cuts early next year

UK interest rates could start to be cut as early as March, some City investors believe, after Wednesday’s welcome drop in inflation.

The money markets are pricing in a sharp fall in UK borrowing costs, after the UK inflation rate dropped to 3.9% in November, a bigger fall than expected.

Bank rate is currently 5.25%, a 15-year high. Investors now see a 40% chance that rates will be cut in March 2024, to 5%, with a cut by May 2024 now priced in.

UK interest rates are seen falling below 4% by the end of 2024, with the money markets now pricing in almost 1.4 percentage points over the course of next year.

Following this morning’s lower-than-expected UK inflation data, investors are now betting on almost 1.25 percentage points worth of rate cuts next year, taking the @bankofengland rate down to 4 per cent by the end of the year. pic.twitter.com/jvcCfpxC5n

— Ed Conway (@EdConwaySky) December 20, 2023

The drop in inflation is putting pressure on the Bank of England to rethink its position that it’s too early to consider cutting interest rates.

Having been criticised for not reacting quicker to the inflationary upsurge in 2021, critics now warn the BoE could be too tardy in responding to the drop in inflation in recent months.

Sanjay Raja, Deutsche Bank’s chief UK economist, called yesterday’s inflation report a welcome Christmas surprise, adding that it:

….raises further downside risks to the Bank of England’s inflation projections – raising the likelihood of a more dovish pivot in February.

Introduction: Warner Bros Discovery and Paramount CEOs in merger talks

Good morning, and welcome to our rolling coverage of business, the financial markets, and the world economy.

Hollywood loves a romantic Christmas movie. But this year, the spotlight is on a possible coupling between two of the largest US media companies.

Warner Bros Discovery and Paramount Global are in early talks over a potential merger, according to multiple reports this morning.

News website Axios reported overnight that Warner Bros. Discovery’s CEO, David Zaslav, met with Paramount Global CEO Bob Bakish on Tuesday in New York City to discuss a possible deal that would bring together two of Hollywood’s “Big Five” studios.

The talks come as media groups struggle to improve their profitability as they battle Netflix in the “streaming war” to win eyeballs.

A merger could bring Warner’s Max streaming service together with current rival Paramount+, to better rival Netflix and Disney+.

Axios reports:

Zaslav also has spoken to Shari Redstone, who owns Paramount’s parent company, about a deal.

WBD’s market value was around $29 billion as of Wednesday, while Paramount’s was just over $10 billion, so any merger would not be of equals.

Axios says the pair discussed ways their companies could complement one another.

As well as a streaming tie-up, CBS News could be combined with CNN to create “a global news powerhouse” while CBS Sports’ footprint could be combined with WBD’s.

But….the talks between Zaslav and Bakish were “at an early stage”, the Financial Times says, meaning a deal might not materialise.

The FT adds:

The conversation was more of an expression of interest by Zaslav than an offer, according to one of the people familiar with the meeting between the two executives.

Also coming up today

There’s still time for a few important data releases before the markets shut down for Christmas, with the latest UK borrowing figures being released this morning.

We also find out how many Americans filed new unemployment claims this afternoon – a gauge of the health of the US labor market.