The recent performance of the UK has been characterised by weak growth and inflation that is high and above that in comparable countries. Indeed, at the end of 2022, the Bank of England was forecasting a two-year recession.
The outlook for 2024 could hardly be more different. UK growth is set to pick up to a firm pace and headline inflation should fall to the 2% target in April and stay there for the rest of the year. After all the criticism of the BoE for allowing UK inflation to get out of control, you might expect monetary policymakers to be delighted at this prospect. But the problem is that the fall to 2% inflation, even though it should be maintained throughout the year, is heavily influenced by one-off effects. Wage inflation is too high for comfort and the indications from all the surveys is that wage inflation could remain high for several months.
With economic growth picking up, the BoE will be afraid to cut interest rates too quickly for fear that high wage inflation will lead to a rise in broader above-target inflation in 2025. A real dilemma.Â
To understand why inflation looks set to hit 2% in April and remain there for the rest of the year, we should start with household energy bills. These will fall by 14% in April and should decline by a similar amount in July.
In April 2023, household energy bills rose by close to 100% on the year previous. This April they will have fallen by 32%. These effects will strongly depress inflation but only in 2024, given the outlook for wholesale prices. Sterling is another one-off effect: it was very weak in 2022 and the lagged impact boosted UK inflation significantly in 2023. Sterling has risen since 2022 and will help to depress inflation this year. Â
All this is good news but unless it feeds through into lower wage inflation, the impacts will be temporary. The problem for the BoE is that their own surveys of companies suggest that wage increases of 5% or so are in the offing this spring. Other surveys point to similar figures. The 9.8% rise in the minimum wage in April will add to these worries.
We do expect wage inflation to slow but it needs to settle at around 3% for the BoE to be confident about cutting interest rates. With signs that the UK economy is set to pick up strongly after the weak growth towards the end of last year, they will be in no hurry to cut rates. This will not go down well with the Conservative Party, well behind in the polls. The government has been careful not to criticise the BoE but backbenchers have not been so hesitant. We expect calls to cut rates will grow as the general election approaches and inflation remains at 2% for several months.
The US central bank is already in the political spotlight with vocal criticism from Donald Trump. The US Federal Reserve has also pushed back on the market pricing for early rate cuts, at least in part because the US economy has been so strong. Only in Europe has the macro data remained weak.
We still think global interest rates will fall further but the timing keeps getting pushed out and, as we are constantly reminded, it’s all data dependent.
I’ll be giving more detail around all these views and more in my webinar on Wednesday. Speak to your Columbia Threadneedle Investments contact if you’d like to sign up.
