Our Privacy Statment & Cookie Policy
All LSEG websites use cookies to improve your online experience. They were placed on your computer when you launched this website. You can change your cookie settings through your browser.
In the UK, the Bank of England’s (BoE) stance on monetary policy and the future path for interest rates have been hot topics since the beginning of the year, and for good reason. Opposing forces, of both stagnating economic growth and stubborn inflation, are expected to have an impact on UK interest rate decisions in 2025. However, on the whole, Fathom does not expect interest rates to reduce much, with just one cut forecast over the course of 2025.
Refresh this chart in your browser | Edit the chart in Datastream
Stagnating economic growth has been a recurrent issue for the UK in recent years. However, growth has fared particularly poorly in the past few months. GDP figures for September and October 2024 point to two consecutive months of contraction for the first time since the pandemic. Coupled with this, UK consumers and businesses seemed to have zeroed in and been spooked by the tax increases announced in an otherwise expansionary budget. As a result, one can expect growth figures for 2024 Q4 and 2025 Q1 to continue to disappoint, with Fathom expecting downside risks to the consensus forecast of 0.4% growth in 2025 Q1. This has created some pressure on the BoE to cut rates, in order to provide support to a slowing economy.
Refresh this chart in your browser | Edit the chart in Datastream
However, inflation trends could be working against the central bank’s ability to deliver on any significant cuts. Consumer Price Index (CPI) inflation has almost exclusively been higher than the Bank of England (BoE) target of 2% since 2021. Although headline CPI inflation briefly returned below target in September 2024, stubbornly high core-CPI inflation figures always casts some doubts on the sustainability of this trend.
Refresh this chart in your browser | Edit the chart in Datastream
Want more charts and analysis? Access a pre-built library of charts built by Fathom Consulting via Datastream Chartbook in LSEG Workspace.
The post-pandemic spike in inflation has materially changed inflation expectations in the UK, which has manifested itself as elevated levels of private-sector regular wage growth. The higher levels of private-sector regular wage growth are both a cause and an effect of higher core-inflation figures, resulting in a vicious feedback loop that prevents core-inflation from sustainably declining towards target. To be in a position where the UK can sustainably hit the inflation target, the rate of wage growth should be equal to the value of target inflation plus productivity growth, which was in the range of 0–0.75% pre-pandemic. That would take the ideal level of wage growth closer to 2–2.7%, much lower than where it sits currently.
Refresh this chart in your browser | Edit the chart in Datastream
More evidence pointing to the systematic change towards higher inflation expectations comes from the market pricing of Retail Price Index (RPI) linked two-year inflation swaps, which have averaged 4.6% since 2022, compared to 3% in the 2010 to 2020 decade. The steady increase in ten-year government bond yields can be explained partly by market expectations of higher inflation and the future path of interest rates as a response to it.
Refresh this chart in your browser | Edit the chart in Datastream
Refresh this chart in your browser | Edit the chart in Datastream
A combination of elevated core-inflation figures and high wage growth, and the feedback loops between them, paints a picture consistent with significant upside risks for the outlook of UK headline inflation in the short- to medium-term at least. As highlighted, fiscal policy is likely to remain a further focus for both the economy and markets. The government’s Autumn budget 2024 unveiled a series of initiatives that Fathom believes will be net expansionary, and accretive to debt from the second half of 2025 and beyond. While the increased fiscal outlay is expected to stimulate growth in the UK economy, it will also add upward pressure on inflation, exacerbating pre-existing dynamics and further diminishing the chances of rate cuts in 2025 by the BoE.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
______________________________________________________________________________________
Financial time series database which allows you to identify and examine trends, generate and test ideas and develop viewpoints on the market.
LSEG offers the world’s most comprehensive historical database for numerical macroeconomic and cross-asset financial data which started in the 1950s and has grown into an indispensable resource for financial professionals. Find out more.
Economists will often borrow theories and techniques, devised by other disciplines, to ...
Similar to events in France and Germany, Canada also faces political upheaval, and ...
Donald Trump was inaugurated this week, being officially given the keys to the White ...
It has been ten years since the People’s Republic of China launched its ‘Made in ...