The week ahead
Each week our UK economist, Tom Pugh, analyses one important topic for the UK economy and gives a forward look at the upcoming data.
16 September 2024
Bank of England to press pause on rate cuts this week
The European Central Bank (ECB) cut interest rates last week to 3.5% and the Fed is almost certain to cut rates in the US on Wednesday. The only question is whether it’s a 25 basis point (bps) cut or a 50 bps one (we think a 25 bps cut is more likely). The Bank of England (BoE) will then look like a bit of an outlier if it keeps interest rates on hold on Thursday as expected – financial markets are pricing in just a 23% chance of a cut on Thursday.
This isn’t because of worries about a resurgence in inflation. In fact, almost all the data since the last Monetary Policy Committee (MPC) meeting at the start of August has moved in the right direction, at least as far as the MPC is concerned.
Admittedly, headline inflation has rebounded and will continue to rise a little due to stronger energy prices. But natural gas prices have fallen considerably in September. More importantly, services inflation has dropped, wage growth has slowed and the two consecutive months of flatlining GDP growth have reduced the risk of the economy overheating. What’s more, forward-looking data such as the PMIs suggests that price pressures are continuing to ease, especially in the crucial services sector. Even the MPC’s own forecasts from last month have CPI inflation falling to 1.7% in Q2 2026 and 1.5% in mid-2027.
The one area of potential concern is the labour market. The official measure of employment jumped by 265,000 in July and the unemployment rate dropped to 4.1%, well below the MPC forecast. A rebound in hiring could lead to higher wage growth and inflation. However, the official labour market figures are unreliable at the minute and other measures of employment are much weaker. On balance, we think there is still plenty of slack in the labour market, especially among younger workers.
All that suggests then that the MPC could justify a rate cut if it wanted to. However, at its last meeting, the MPC made clear that it was going to take a very cautious and gradual approach to lowering interest rates this year. Recall that even for those members that voted to cut, the decision was "finely balanced". And Bank Governor, Andrew Bailey, said the committee is cautious about cutting “too quickly or by too much”.
That essentially rules out a rate cut on Thursday. But it leaves the door wide open for more rate cuts later this year. We currently expect the next UK rate cut to come in November and there’s a good chance of another one in December. Even if there are two more rate cuts this year, it would leave interest rates at 4.5%, which would be higher than markets are pricing in for the eurozone (3%) and the US (4.25%), leaving plenty of room for more aggressive cuts in 2025.
- Inflation ticking back up
- Households and retail sales
Inflation ticking back up
Headline CPI inflation likely accelerated in August, rising to 2.3% from 2.2% in July. The BoE pencilled in a reading of 2.4% in its August forecast.
The rise in the headline rate will be driven by a pickup in services inflation to 5.5% from 5.2%. Airfares and hotel prices are likely to be behind the move higher — both are extremely volatile, which is why we doubt the data will alarm the BoE.
What’s more, if services inflation rises in line with our expectation, it will still be 0.3 percentage points (ppt) below the BoE’s August forecast.
A fall in fuel prices on the month will push down on the 12-month rate - prices decreased by 1.5% this year compared to a 3.8% rise at the same point in 2023.
The BoE faces the prospect of a resurgence in headline inflation in the second half of the year on the back of rising household energy bills. Still, assuming measures of underlying inflation continue to ease and GDP growth moderates, we think the central bank will be comfortable easing again. We expect the next cut in November.
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Households and retail sales
We expect UK retail sales to have ticked up in August as the warmer weather likely boosted spending on summer clothing and food for barbecues.
While many households still feel the hangover from the cost-of-living crisis, the pressure is easing as wage growth surpasses inflation, leaving more change in people’s pockets.
The loosening in fiscal policy through lower National Insurance contributions is supporting incomes. A near-10% rise in the National Living Wage from April benefited almost three million low-paid workers. That will continue to support the high street as this group tends to have a higher marginal propensity to spend.
The BoE’s rate cut in August will also help sentiment. It will boost the spending power of 18% of households on variable mortgage deals.
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