The Bank still believes it has broken the back of inflation and expects the medium-term weakness of the economy to bear that out. But with last year’s big drops in energy prices falling out of the annual calculations, headline inflation is set to remain clearly above its 2 percent target this year. After having fallen to a three-year low in September, it had already rebounded to 2.5 percent by the end of last year.
That, said the Barclays economist, creates something of a dilemma for the MPC, which has to balance the risks of an undershoot over the longer period against the risk that inflation expectations become unmoored in the immediate future, sowing the seeds of a new price cycle.
After surprisingly strong growth in the first half of the year, U.K. gross domestic product didn’t grow at all in the three-month period from September to November, as households and businesses reacted negatively to a first budget from the new Labour government which raised taxes without really making a dent in the deficit.
Analysts at Barclays expect the Bank to slash its 2025 growth forecast by 0.5 percentage points, to 1 percent, reflecting the loss of momentum over the turn of the year.
All of that speaks to more interest cuts in the short-term: Alan Taylor, the MPC’s newest appointee and seen by many as an intellectual heavyweight, said in a speech last month that the balance of risks had clearly shifted and that Bank may need time to cut as many as six times this year to support the economy. Analysts at Berenberg wrote that that could mean back-to-back cuts at the February and March meetings, breaking with recent practice that has seen the Bank act only when it updates its quarterly forecasts.
But at the same time, wages — a key element of service sector inflation that has been uncomfortably high for three years — most recently accelerated again: Private-sector average weekly earnings, excluding bonuses, rose at an annual rate of 6 percent in the three months through November. And Berenberg’s analysts pointed to signs in recent business surveys that the gentle trend downward in prices is also bottoming out.
