• Bank Rate cut to 4.50% as BoE halve growth forecast for 2025 and expect inflation to rise
• Mortgage market activity holds up in December for a strong end to 2024
• Household savings balances grow by nearly £100 billion in 2024

UK economy heading for stagflation as bank cuts rates to boost growth

1.       On 6 February the MPC committee voted 7 – 2 to cut the Bank Rate by 25 basis points, with two members voting to cut by 50 basis points given the weak outlook for the UK economy. The Bank deemed that enough progress on disinflation had been made over the past two years to allow some additional easing in monetary policy, but will maintain the Bank Rate in restrictive territory to squeeze out persistent inflationary pressures. The Bank have also published their latest set of forecasts in their February Monetary Policy Report in which GDP growth for 2025 was cut to 0.75% -half of what was expected in November 2024 at 1.50%. Inflation is now expected to be 3.50% in 2025, up from 2.75% forecast in November, before ultimately falling back. This suggests the UK could be entering an undesirable period of stagflation – low growth and high inflation.

2.       UK GDP growth is estimated to have been zero in Q3 202 and have reduced by 0.1% in Q4. Demand has weakened but so has supply due to very weak productivity growth, meaning the amount of slack in the economy is expected to widen, but only marginally. The expected downward path of Bank Rate will boost demand, which will boost GDP growth from the middle of 2025.

3.       CPI rose by 2.5% in the 12 months to December 2024, down from 2.6% in the 12 months to November. However domestic inflationary pressures are moderating. Core CPI (excluding energy, food, alcohol, and tobacco) rose by 3.2% in the 12 months to December 2024, down from 3.5% in November, and the closely watched CPI services annual rate also fell from 5.0% to 4.4%. The Bank expect higher global energy costs and regulated price changes to push up inflation, to around 3.7% by late summer, but this is not expected to lead to additional ‘second-round’ effects on underlying domestic inflation. Therefore, core inflation is expected to fall in line with their previous forecasts in November.

4.       This judgement on core inflation in part reflects labour market conditions, which are much looser than in November. The Bank now judges the labour market to be broadly in balance based on their analysis of the vacancies to unemployment ratio which is now deemed to be at its long-term equilibrium rate. The estimated number of vacancies in the UK decreased by 24,000 to 812,000 in October to December 2024. This is the 30th consecutive decline but numbers are still above pre-covid levels.

Vacancies to unemployment ratio and estimated equilibrium values

5.       The unemployment rate in September to November was 4.4%, up from 4.3% in August to October and wage growth (total pay) grew by 5.6% up from 5.2%. Whilst wage growth has been higher than expected it is now forecast to moderate significantly in 2025 as labour market conditions continue to ease and past falls in inflation expectations feed through.

6.       There is a great deal of uncertainty over the UK economy and outlook for inflation. One key driver of inflation will be how firms deal with higher labour costs from higher wages and increases to employer NICs. Whether firms pass on these costs to consumers, which pushes up inflation, or absorb the costs will depend in part on the strength of demand in the economy as well as the competitive pressures. According to the Bank’s Agents firms in consumer-facing industries expect to raise prices in 2025, though many think they will need to do so gradually so as not to disrupt sales. On the other hand, recent surveys suggest that firms may have to accept lower profit margins in response to the higher rate of employer NICs.

7.       Another uncertainty is around external factors such as the imposition of trade tariffs by the US, which could also impact the inflation outlook. The Bank has provided a full analysis of how trade tariffs could affect the economy in the February Monetary Policy Report. Tariffs would likely have adverse effects on UK activity but the net effect on UK inflation is highly uncertain. Amongst other factors, announcements by the new US administration helped shift interest rate expectations considerably in recent months as shown in the chart below. Current market rates (as of 7 Feb) suggest a further 65 basis point cut to Bank Rate by the end of the year to reach 3.89%, and it to be around 3.81% in five years.

CPI inflation is expected to fall but the MPC say monetary policy needs to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. However, with so much uncertainty, both domestic and globally, the rate at which monetary policy will ease is far from given, and the minutes to the MPC meeting making a distinction between “gradual and careful” cuts and slower “cautious and gradual” cuts if evidence shows supply is constrained and inflation is more persistent.

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