UK: Slower growth, faster inflation, gradual tightening
|Summary
- The U.K. economy is displaying increasingly divergent trends. CPI inflation has continued to trend higher, reaching 5.4% year-over-year in December, and could peak as high as 6.5% to 7.0% before inflation begins to recede. In contrast, U.K. activity growth is likely to experience temporary softness around the turn of the year related to a surge in COVID cases, and face headwinds from reduced consumer purchasing power later in 2022.
- While elevated inflation will clearly warrant further Bank of England tightening in our view, subdued growth suggests those rate increases will be delivered at only a gradual pace from the U.K. central bank. Specifically, we expect the Bank of England to hold its policy rate steady at 0.25% at its early February monetary policy announcement. More broadly, we forecast a cumulative 50 bps of Bank of England rate hikes over the next year, well below that currently expected by market participants.
- This more gradual view of Bank of England tightening is an important influence behind our view of a weaker pound over time. We forecast for a softening in the GBP/USD exchange rate towards $1.2900 by the end of 2022, and to $1.2700 by the middle of 2023.
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