“Markets are pricing a 0.25% pa cut to the Bank of England’s (BoE) base rate tomorrow, with forecasts for a further two cuts in 2025, taking the base rate to 4.0% pa by year-end. While interest rates’ current level allows for a modest reduction, the stagflationary shock from the national insurance (NI) increase announced in the Autumn Budget, alongside high underlying measures of inflation, means the BoE is likely to adopt cautious messaging about cuts.
“Sure, the economy is showing little momentum, but the BoE’s mandate is price stability. And there are plenty of datapoints to keep it vigilant. The disinflation in goods, food and energy prices is now in the rear-view mirror and set to become a positive contribution in the year ahead. Consensus forecasts suggest UK headline inflation will rise to 3.0% year-on-year in the autumn. There are also questions about whether the BoE will be to ‘look through’ the forthcoming rise in headline inflation. Average weekly earnings growth rose 5.6% year-on-year in the three months to end-November, contributing to upwards pressure on sticky service-sector inflation, which was up 4.4% in the 12 months to end-December.
“Having said that, the BoE is going to have to walk a tightrope in the year ahead. The economy is stagnating, and the announced NI increase has driven growth and inflation in opposite directions: employment intentions have fallen while expected price growth and services output prices have risen, as employers cut back recruitment or look to pass on the NI increase via prices. Should weaker employment growth result in dwindling domestic demand and a larger output gap, reducing inflation pressure, we expect the BoE to cut rates more quickly. However, if inflation pressures persist, despite the weak growth backdrop, the central bank is likely to stay cautious.”
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