This week saw inflation move further above the Bank of England’s 2% inflation target, strong pay growth figures and a Bank of England keeping rates on hold amid some fairly substantial uncertainty around the UK economic outlook.
The signs are growing that the October Budget has been digested poorly with business optimism deteriorating and warning signs in survey data around the employment outlook. The combination of recent GDP figures and business surveys suggests that the UK economy may well contract in Q4 (albeit only mildly). I still expect the Bank to cut three times in 2025, which is faster than the market expects and with risks of more. Unfortunately, for now at least, the inflation data and inflation outlook don’t leave the Bank of England lots of scope to speed up the pace.
With inflation, as ever, it really matters what is happening beneath the surface. We know that headline CPI can get buffeted around by things like oil prices, but looking through that to recent core and services inflation the picture is still of UK inflation running a bit too strong for comfort. There was a pick up in core goods inflation in November and with services inflation around 5.0% the data isn’t yet consistent with sustainably hitting a 2% inflation target.
“The UK economy doesn’t seem to be doing particularly well at the moment, and downside risks are mounting”
Aside from actual inflation outcomes, two other recent developments have been notable here. First, we saw really quite strong private sector pay growth of 6.4% year-on-year for November. That will be well above inflation-target consistent levels given relatively weak long-term UK productivity trends. Second, we’ve seen medium-to longer term consumer inflation expectations rise significantly. On the latter, Bank of England policymakers in the minutes did sound a little worried that the rise in inflation expectations might reflect a “greater attentiveness among households to cost-of-living increases, such as the reduction in winter fuel payments…successive increases in the Ofgem price cap…and higher food prices”. They also noted that “these increases might interact with already-elevated inflation perceptions, and thus could add to the persistence of domestic inflationary pressures.”
Not much room for manoeuvre = bad news: The UK economy doesn’t seem to be doing particularly well at the moment, and downside risks are mounting. Yes, the economy may still get a boost from additional public sector spending and consumer confidence appears to have improved post Budget. But it would be more reassuring if there was lots of scope for the Bank of England to cut rates. Policy rates still look well above neutral to me, but the Bank of England is an inflation targeter and recent inflation-related developments and risks raise the bar to speedier rate cuts. If downside risks materialise for the economy, ultimately the Bank will likely end up cutting rates more than in my central case, but it may take a while to get there. There’s plenty of risk next year coming from abroad too of course – not least a new US president who is promising policy discontinuity on several fronts including tariffs on his trading partners, and all alongside ongoing geopolitical risks.
Next rate cut: February: I expect the Bank to keep cutting rates, with the next cut in February. The Monetary Policy Committee think that “a gradual approach to removing monetary policy restraint remains appropriate” and with three members currently wanting to cut rates, a February cut looks on track. But my central case doesn’t yet have them speeding up the pace. Inflation trends look too strong for that. With mixed developments on growth and inflation and some significant uncertainty to wade through (in the form of the impact of the October Budget, geopolitics and trade uncertainty), it makes sense for now to assume a continued gradual approach from the Bank as we head into 2025.
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