Bank of America has predicted the Bank of England will not be able to cut interest rates until after 2024.
In a research note today (1 September), UK economist Robert Wood said the UK has an “entrenched inflation problem”, which has been caused by four supply shocks: energy prices, supply chains, Brexit and workforce sickness.
The weak supply has bled into the UK’s growth prospects, as there has been no actual growth since 2019, leading to a strong domestic inflationary pressure.
Wood explained inflation pressure is now “entrenched to a degree, as the structural economic changes combined with high inflation have modestly deanchored inflation expectations”.
As a result, the economist has forecast the Bank of England will hike rates by 25bps in September to 5.5%, which he expects the central bank will hold at the same level through 2024.
Wood added the sharp drops in the Services Purchasing Mangers’ index (PMI) and the Confederation of British Industry (CBI) retail survey show UK growth is weakening. Yet he noted the PMI has not been a “good guide” lately, as it may exaggerate the slowdown.
On the back of this, BofA expects 0.4% quarter-on-quarter growth in Q3, helped by the bounce back of the extra bank holiday in May, and 0% in Q4. The bank also revised its forecast for the year to 0.6% from 0.4% for the UK, due to real wage growth “soon turning positive”.
This was also caused by a faster-than-expected easing of the UK labour market, Wood highlighted, prompted by the one-off supply improvement from students returning to work. But the “chronic” labour supply problem of increased workforce sickness remains, he added.
Wood explained: “Further labour market easing will likely require weak demand rather than coming benignly from improving supply. We forecast the unemployment rate over the next year to rise at half the pace of the past year.”
This means that, as headline inflation keeps on falling and capacity pressures ease, the BoE will need to shift its focus on inflation persistence, Wood argued.
He explained: “How much spare capacity is needed and how much the BoE needs to hike to deliver that is extremely uncertain. Interest rates are, in our view, in restrictive territory now. The weak housing market testifies to that. It is not so much a question of the BoE catching up with policy anymore, but rather how restrictive rates need to be.
“That will depend on the mixture of shocks. The BoE suggest data surprises have been the result of structural changes that do not necessarily all suggest upside risks to inflation. The BoE will likely be cautious about hiking further.”
BofA expects evidence of core inflation sustainably falling and wage growth stopping its upside surprises to show by the November monetary policy meeting, potentially resulting in a pause to the hiking cycle.
However, it added it is also plausible two more hikes – in November 2023 and February 2024 – may happen as further information on 2024 wage settlements starts to flow in.
Despite all the variables and uncertainty surrounding economic data, Wood concluded that the path to lower inflation for the UK is not going to be “painless”.