- Unexpected rise in inflation
- Bank of England rate-cut uncertainty
- Market reacts to data
The market’s anticipation that the Bank of England will shortly begin to reduce the base rate is diminishing in light of last month’s unexpectedly high inflation data.
December saw its first increase in consumer price inflation in ten months, from 3.9% to 4%, according to new data released by the Office of National Statistics on Wednesday.
This result fell short of expectations for a decline to 3.8% and has dashed prospects for a rate cut.
Early trading saw sterling decline against the US dollar, as two- and five-year gilt yields increased by double digits and the FTSE 100 declined, which reflected diminished expectations that the BoE would begin rate cuts in May.
Although investors anticipate five interest rate cuts in 2024, with the initial reduction occurring in May, this figure represents a decrease from the initial estimate of six cuts for the year.
The market had priced in 170 basis points of reductions on January 1; that figure has since decreased to 115 basis points.
The BoE has refuted expectations of a rate cut in May, maintaining its steadfast stance that the base rate must remain elevated for the foreseeable future.
However, this has not prevented markets from pricing in a roughly 50% chance of a reduction this spring following the Bank’s September decision to halt base rate increases at the current level of 5.25 per cent.
Economists Differ on Rate Outlook
ING’s developed markets economist James Smith stated that anticipations of a cut in May were “possibly premature,” as “more tangible progress” on services inflation and wage growth, as well as a “relatively muted fiscal package” in the March budget, were necessary.
He continued, “At this time, we are planning to reduce rates in August, followed by an additional 100 basis points of easing this year [to 4.25 percent]. However, we will continue to monitor this as fiscal and data-related information becomes available in the coming months.”
Chief strategist at RBC Brewin Dolphin, Guy Foster, stated that Wednesday’s inflation report “did not validate the easing that yesterday’s employment data was pointing to,” following wage growth data from the ONS that indicated a deceleration last month.
Foster further stated that the crucial level of services inflation “appears to be picking” based on the most recent CPI data, which “complicates matters for the BoE.”
Rob Clarry, however, an investment strategist at Evelyn Partners, predicted that the CPI would continue to decelerate as the economy absorbs the effects of previous rate increases and energy prices decline in anticipation of an impending Ofgem price cap cut.
Inflation Factors and Future Outlook
Clarry further observed that the primary factor propelling the CPI in December was the escalation in tobacco duty.
“This was a disappointing inflation report for the Bank of England, but it likely signifies a setback on the path to lower inflation,” he continued.
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As energy costs continue to decline, inflation may return to the target level of 2% by mid-2024, allowing the Bank the flexibility to reduce interest rates.
RSM UK economist Thomas Pugh opined that the potential repercussions of the shipping attacks in the Red Sea are unlikely to be “significant enough to warrant a monetary policy adjustment by the BoE unless the crisis escalates and precipitates a precipitous increase in energy prices.
“Base effects indicate that the inflation rate is likely to fluctuate throughout the first three months of this year, possibly recovering to nearly 4.5% in January before falling below 2% in May,” he continued.
“That will provide the MPC with excellent cover to pivot and begin interest rate cuts.”
