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Market Musings -
UK inflation trends, growth prospects, and BoE's policy dilemma
While inflation currently remains elevated, we anticipate a decline in price pressures, paving the way for headline inflation to hit the Bank of England’s (BoE) target of 2% in the coming months. This would likely prompt the BoE to consider interest rate cuts in the latter half of the year. Additionally, recent upticks in market sentiment indicate a recovery in the economy following a brief technical recession.
Positive trends in CPI
The latest UK Consumer Price Index (CPI) data demonstrates a remarkable improvement compared to what we observed this time last year. In March 2023, CPI inflation surged to a staggering 10.0%, a stark contrast to the current level of 3.4%. Although the current headline CPI remains ahead of the BoE’s 2% target, it signals a re-establishment of the disinflation trend witnessed in recent months.
Notably, services inflation has proven to be a stickier factor in the UK, remaining elevated at 6.1% year-on-year. Nevertheless, there has been a steady improvement on the services front, as wages growth - which is a big influence on services inflation - is starting to normalise. Optimistic forecasts from JP Morgan suggest inflation could decline further to 1.7% by May 2024.
Economic resilience amid recession concerns
Recent GDP figures revealed that the UK had entered a technical recession; defined by two consecutive quarters of negative growth. Other economic indicators paint a more optimistic picture. For example, the tight labour market, solid wages growth and rebounding retail sales, all show signs of stabilisation, if not an outright improvement.
Positive momentum in Purchasing Managers’ Index (PMI) data indicates that the technical recession is potentially over. This resilience is partly attributed to the improved global growth we have seen in recent months. Additionally, rising real wages in the UK fosters stronger consumer confidence, further supporting the economy.
Central bank’s dovish shift
A near-term uptick in UK and global growth could potentially delay the disinflation trajectory observed, however the BoE adopted a more dovish tone in its latest meeting. Despite maintaining interest rates at 5.25%, the central bank signalled a willingness to adapt as the economy landscape evolves.
Notably, two hawkish members of the Monetary Policy Committee (MPC) have aligned with the majority, opting to retain rates. BoE Governor, Andrew Bailey, acknowledged progress but emphasised caution, stating, “We are not yet at the point where we can cut interest rates, but things are moving to the right direction”.
Market response and future considerations
The market is now pricing in the more dovish tone with UK bonds and stocks rallying, and sterling weakened, following the BoE announcement. According to current market pricing, the first cut is anticipated to occur following the August meeting.
The BoE will keep monitoring closely any data that will confirm inflation is heading closer to their target of 2%, such as wages growth slowing and services inflation coming down. As inflation gets lower that will open the door for the BoE to consider cutting rates.
Investment Committee Series
Our Investment Committee share their key decisions and outlook for Q1 2024 here
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