In the financial district, there is a strong belief that the Bank of England’s policymakers have another interest rate increase up their sleeves. However, the outcome largely hinges on the release of the latest official prices data this week and the rate at which inflation is declining.
According to financial markets, there is an 80% probability of a 0.25 percentage-point rise to 5.5% when the Bank’s monetary policy committee (MPC) meets on September 21. The central bank is under significant pressure to bring inflation down to its targeted 2% after a substantial spike in the consumer prices index (CPI) last year, which exceeded five times the target rate. Although the UK’s annual inflation rate declined to 7.9% in June compared to 8.7% in the previous month, economists in the City were surprised by the magnitude of the drop. Nevertheless, price hikes in the UK still outpace those of most industrialized nations, with France at 5.3%, Germany at 6.8%, and the eurozone average at 5.5%. In contrast, US inflation remains around 3%.
During the Bank’s last meeting, deputy governor Ben Broadbent emphasized that the increase in wages growth indicated an end to the era of falling living standards. Huw Pill, an MPC member and the Bank’s chief economist, believes that the 14 consecutive interest rate hikes, resulting in the highest level in 15 years, have been effective. These rate hikes have increased borrowing costs and led businesses and households to rein in spending.
In its most recent report, the Bank predicts that inflation will dip below 5% by the end of the year, assuming that interest rates peak at 6%. However, analysts are of the opinion that a peak of 5.5% may already be sufficient to achieve this target.
Economist Samuel Tombs from Pantheon Macroeconomics anticipates a drop in inflation to 6.8% in July due to the reduction in the energy price cap implemented by Ofgem on July 1. This cap limits the amount suppliers can charge for gas and electricity, resulting in a yearly equivalent of £2,074 for households purchasing both utilities from the same provider, down from £2,500 under the government’s energy price guarantee. Tombs also points out that lower petrol and diesel prices, which have significantly fallen since last year, have contributed to the decrease in inflation. Nonetheless, this downward trend is expected to last for only another month.
The Bank of England’s Pill will closely monitor labor market figures and earnings data which will be released next week. Analysts were taken aback in May when the figures showed a 7.6% surge in average pay, driven by a 9.2% increase in the earnings of workers in the finance and business services sector. The Bank expects to identify an acceleration in earnings that exceeds inflation. Deputy governor Ben Broadbent has expressed concerns about sustained high wage growth, as this would create a feedback loop into prices. However, it is important to note that wage data only reflects deals reached six months ago or longer.
Sandra Horsfield, senior economist at Investec, predicts that inflation will decline to 4% by the end of the year and continue to fall alongside a decrease in wage rises. Her main concern centers around the volatile global energy markets, which could potentially lead to skyrocketing prices, even without an escalation of the conflict in Ukraine.
Recent events in Western Australia, where 700 workers threatened to strike, causing a 30% surge in European gas prices, serve as a warning to those who believe that the UK has resolved its inflation problem. The potential closure of processing plants capable of exporting around 10% of the world’s liquefied natural gas has significant implications.
Additionally, when rail ticket prices for the following year are calculated this week, they may undermine inflation forecasts. The government uses the July retail prices index (RPI) to determine rail prices for January. In June, RPI stood at 10.7%, and only a slight decline is expected in July, which will further exert pressure on inflation in 2024.
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