The Bank of England has warned that fears over Rachel Reeves’s looming tax raid will weigh on growth well into 2026.

Andrew Bailey signalled that households were holding back on spending ahead of the Budget, which is widely expected to include significant tax rises to plug a black hole in the public finances.

The Governor raised the prospect of an interest cut before Christmas to support the economy, as Threadneedle Street blamed higher taxes and employment costs for a stagnant jobs market. 

The Monetary Policy Committee (MPC) voted 5-4 to keep interest rates on hold at 4pc on Thursday, with Mr Bailey casting the deciding vote.

Following its decision, the MPC said households and businesses were already worried about the Budget on November 26, with more bosses describing the uncertainty facing their businesses as “high” or “very high” than in the aftermath of Liz Truss’s mini-Budget.

A survey of households and businesses conducted by the Bank described the economy as “flat” as Mr Bailey said he was confident inflation had peaked at 3.8pc.

The poll added: “Increased uncertainty about the upcoming autumn Budget means contacts do not expect demand to pick up until at least partway through 2026.”

Businesses said they were still dealing with the fallout of the Chancellor’s £25bn increase in employer National Insurance rates, while big businesses blamed Labour for making the UK less attractive as an investment destination.

It comes after the Chancellor has signalled that Labour is preparing to break a key manifesto pledge not to raise income tax at the Budget, warning this week that “we will all have to contribute” to get debt down and fund the NHS.

Ms Reeves also described rates at 4pc as “a constraint on business borrowing and a burden on family finances”, as she said the Government would play its part in “getting inflation falling and creating the conditions for interest rate cuts”.

Mr Bailey refused to speculate on how tax increases could influence the future path of interest rates.

“In no sense are we passing any judgement over what the Chancellor said this week, that should be very clear,” he said. “We will have to consider the Budget in the next round.”

However, in welcome news for borrowers, Mr Bailey said it was “fair” to say he backed two more interest rate cuts by next spring in a move that would see borrowing costs reduced to 3.5pc.

The Bank warned that economic growth was likely to slow from 1.5pc this year to 1.2pc in 2026 as unemployment peaks at a higher rate of 5.1pc, up from earlier forecasts of 4.9pc.

Policymakers warned that cautious households were unlikely to boost growth.

“The outlook for household spending is a particular concern,” the MPC said as it warned that households were saving more and spending less in a sign of consumer caution, despite a recovery in real income growth.

Mr Bailey said he saw “further policy easing to come” if the economy continues to cool, as he described the recent stability in price rises as “promising”.

However, MPC member Alan Taylor, who voted for an immediate rate cut, warned that unemployment was likely to peak well above 5pc.

Mr Taylor, who has previously raised the prospect of the UK tipping into recession, said: “Peak unemployment is yet to come” and “may endure for some time”.

The Bank said government policies were to blame for a large share of the current overshoot in inflation from the Bank’s 2pc target. 

Currently running at 3.8pc, the Bank expects the rate to have fallen to 3.6pc in October. However, it is not expected to get back to target until the end of 2027, and it warned that food inflation was likely to remain “elevated”.

The Bank said increased labour costs driven by Ms Reeves’s decision to raise the minimum wage and employer national insurance contributions were the biggest factors behind the current overshoot.

Policymakers warned that employers had already been forced to make tough decisions as a result of Ms Reeves’s tax raid.

“Nearly half of the firms responding to the latest survey indicated that, in response to changes in employer NICs, they had already lowered employment by more than they would otherwise have done,” the Bank said.

It signalled that a higher minimum wage and demands for inflation-busting increases from “unionised” workforces were likely to be the source of the biggest pay pressures going forward.

It said many employers were responding to higher costs by handing out smaller pay rises to senior staff.

Mr Bailey said higher road tax, water bills and other regulated prices were also pushing up prices as he signalled that Ms Reeves recognised that she had played a role in driving up inflation.

He said: “The question is what comes next. I do think it’s a point that the Government has taken about the impact that these things can have on inflation and therefore on policy setting.”

Mr Bailey added: “It’s for the Government to decide its policy because Government has all sorts of public policy objectives.

“I think we have to draw attention to the effect of these which we do – and then factor them into our outlook.”

Responding to the Bank’s decision, Ms Reeves said she would take “fair choices” in the Budget to enable the Government to “cut waiting lists, cut the national debt and cut the cost of living”.

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