- Forecasters expect inflation to return to the 2 per cent target over the next few months
- But BoE rate-setters remain divided on the right time to make cuts
The UK headline rate of inflation stayed at 4 per cent in January despite economists expecting it to rise, opening a small window for potential rate cuts in the summer.
Core inflation, which strips out more volatile food, energy and tobacco prices also stayed the same as last month's 5.1 per cent.
According to the Office for National Statistics (ONS), higher household and household services pulled the figure upwards. More positively, significant downward contributions came from food and furniture. The rate of inflation has now been above the Bank of England’s 2 per cent inflation target for 30 months in a row.
Inflation should soon return to target
The inflation rate has fallen significantly since peaking at 11.1 per cent in October 2022 – the highest rate since 1981. Despite bumpy progress, the figure is expected to fall sharply within a matter of weeks as the impact of lower wholesale gas prices feeds through to inflation data. The BoE’s forecasts now imply that inflation will hit 2 per cent by the second quarter of the year. Rate-setters previously expected this process to take until the end of 2025.
Rate-setters remain divided
Yet the case for policy easing isn't as clear cut as the updated forecasts imply. The Bank expects inflation to rebound again towards the end of 2024, and remain above 2 per cent (though only marginally) thereafter.
Governor Andrew Bailey pushed back against market expectations of rate cuts earlier this month, warning that “it is not as simple as inflation falling to target in the spring and the job being done”. Hawks on the Monetary Policy Committee remain concerned about wage growth and services inflation, and two voted for a further 0.25 percentage point interest rate hike in the last meeting (see chart).
Yesterday, wage growth came in at 5.8 per cent for the three months to December, down from 6.7 per cent the month before but ahead of expectations, with economists hoping for something around the 5.6 per cent mark. This caused a slight headache for any optimistic rate-cut watchers. The probability of the first cut coming in June had already fallen ahead of today's inflation update.
Nevertheless, the February meeting saw the first vote of the cycle for an interest rate cut. Rate-setter Swati Dhingra cautioned that waiting too long for data carried a risk of overtightening, while the committee as a whole dropped any reference to the possibility of further rate hikes.
We will see cuts this year
The door is certainly open to interest rate cuts, but economists are split on when they might come about. Kallum Pickering, senior economist at Berenberg, thinks that by the March meeting, positive inflation data should persuade all nine rate-setters that rates have risen high enough. This should pave the way for a first cut in June, or even May this year.
Analysts at Capital Economics think that inflation could fall faster and further than the BoE anticipates. Their base case is also a first cut in June, with rates falling to 3 per cent by the end of next year. This could see the 10-year gilt yield drop from around 4 per cent today to closer to 2.35 per cent by the end of 2024, and the pound weaken from $1.26 today to around $1.20.
