Bank of England set to join the 'higher for longer' club

Summary

• The U.K. economy has continued along its disinflation path in early 2024, but at a more gradual pace than previously, as this week's wages and price data both surprised to the upside. At the same time, there are nascent signs of U.K. economic recovery. Sentiment surveys have been on an overall improving trend for the past several months, while January and February GDP outcomes point to a return to positive growth after the U.K. economy contracted during the second half of 2023.

• A slower pace of disinflation could make Bank of England (BoE) policymakers cautious about lowering interest rates prematurely, while signs of economic recovery arguably reduce the urgency for monetary easing. Against this backdrop, we now forecast later easing than previously from the BoE. We forecast an initial policy rate cut to 5.00% at the August monetary policy meeting, followed by 25 bps rate cuts in November and December, for a cumulative 75 bps of rate cuts this year, which would see the policy interest rate end 2024 at 4.50%. We see a further cumulative 125 bps of BoE policy rate cuts in 2025, which would see the central bank's policy rate end next year at 3.25%.

• Overall we expect the BoE to deliver modestly more easing than anticipated by market participants this year, and forecast noticeably more easing than expected by market participants next year. Over the medium-term, that could contribute to downward pressure on shorter-term U.K. bond yields, and see the pound underperform relative to many other G10 currencies over time.

A slowdown in the UK inflation slowdown

A range of important economic figures from the U.K. this week pointed to an ongoing easing of inflation pressures, though perhaps not as quickly as Bank of England (BoE) policymakers might have hoped for. Most notably, the U.K. March CPI surprised to the upside as headline inflation slowed to 3.2% (versus a consensus forecast for 3.1%), and the core CPI slowed to 4.2% (forecast 4.1%). Services inflation barely edged lower to 6.0%, versus an expected print of 5.8%. While the March figures represented some further progress on the disinflation front, the improvement was much less than what was seen in February. Core and services inflation in particular—that is, measures of underlying inflation—remain well above the 2% inflation target.

Energy-related base effects should see headline inflation slow sharply in April, and while base effects will also be beneficial for core and services inflation, we expect these underlying inflation measures will follow a more gradual path, relative to headline inflation, toward the central's bank inflation target. The latest labor market figures are, in our view, also consistent with only a gradual deceleration of services and domestic inflation. Those data showed some further slowing in wage growth, but at a measured pace. For the three months to February, average weekly earnings excluding bonuses rose 6.0% year-over-year, a bit less than the 6.1% increase seen in January, but higher than the consensus forecast for a 5.8% gain. Private sector earnings rose 6.0%, while public sector earnings rose at a slightly faster 6.1% pace. To be sure, there are some signs of softening in the labor market that could portend a further slowdown in wage growth ahead. While acknowledging some caution surrounding labor market data given the low response rate to the surveys recently, data nonetheless showed the unemployment rate rising to 4.2% for the three months to February, compared to 4.0% for the three months to January. In addition, employment declined by 156,000 in the three months to February compared to the three months to November. The loosening in the labor market and the slowing in wage growth should allow for Bank of England rate cuts in the months ahead, but could also make central bank policymakers somewhat cautious about just how aggressively to ease their monetary policy stance.

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