UK Inflation Is Set to Ease, But Not as Quickly as Markets Hope

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(Bloomberg) — Inflationary pressures in the UK are set to ease again this week, though not as quickly as investors are hoping as they bet on a swift round of interest-rate cuts.

Official data on Wednesday is likely to show the Consumer Prices Index eased to 3.8% in the year through December from 3.9% the month before, a survey of economists by Bloomberg showed. Labor market figures the day before may show slowing wage growth and falling job vacancies.

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The figures if they pan out as expected would show Britain is shedding its status as having the worst inflation problem in the Group of Seven nations. That would open the way for the Bank of England to shift toward rate cuts in order to prop up a stagnant economy. BOE policy makers led by Governor Andrew Bailey warn that they have a way to go in reining in a wage-price spiral.

“We had this euphoria moment with the inflation numbers that came out in December,” said Yael Selfin, chief economist at KPMG UK. “Numbers this month are going in the right direction leading us to a gradual reduction — potentially allowing the Bank of England to cut rates a bit earlier — but not as quickly as markets are factoring in at the moment.”

Investors in recent days have pared back the scale of rate cuts they’re expecting this year. Money markets are betting on five quarter-point reductions this year with an additional 30% chance of a sixth. Just a few weeks ago, they were almost certain about the sixth cut.

Economists expect the core measure of inflation stripping out volatile food and energy prices to drop below 5% for the first time in two years, which would strengthen the case for lower rates. Services inflation meanwhile is likely to stick above 6%, and that measure is one BOE officials have said they’re watching.

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“Disinflation is likely to happen faster than thought a couple of months ago, but it is still much slower than elsewhere, particularly when it comes to services inflation,” said Agne Stengeryte, a strategist at Bank of America Merrill Lynch. Its economists expect the first quarter-point interest-rate cut to come in August, five months after the US Federal Reserve and two months following an expected move by the European Central Bank.

Jobs data due Tuesday are expected to show signs the labor market is loosening, which would reduce some of the inflationary pressures the BOE has watched with concern. Average earnings growth excluding bonuses probably slowed to 6.6% in the three months to November from 7.3% previously. 

There’s a chance of an upward surprise in the wage figures, which have proved more sticky than the BOE has anticipated. The Recruitment and Employment Confederation earlier this month said pay pressures increased in December, reflecting a lack of applicants for available jobs.

“For those lucky enough to start a new role there was another sharp increase in starting salaries due to competition for skilled workers,” Justine Andrew, head of education, skills and productivity at KPMG UK, which contributed to the REC report. 

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Central bankers around the globe have said the last mile in the battle to return inflation to the 2% target will be the hardest. CPI in the US picked up at the end of 2023, fueled by sticky service costs. In the eurozone, energy base effects are likely to trigger a rebound in price readings due in the coming days.

“The UK is behind the US and Eurozone in terms of inflation coming down and our inflation in November was still closer to closer to 4% than to 3% as it has been in those other countries,” said Tera Allas, director of research and economics at McKinsey in the UK. “I expect our inflation to continue to come down, but I don’t expect the speedy trajectory to continue anymore, it would be more of a gentle reduction.”

The likely fall in headline inflation will “reflect a broad easing in price pressure, with the food, services and core goods inflation all cooling. The movements in the latter two categories mean core inflation should drop to 5% from 5.1% in November,” according to Dan Hanson and Ana Andrade of Bloomberg Economics. “The wild card in the CPI release is airfares — large monthly rises in December have been the source of forecast errors in past years.”

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This month’s labor market report from the Office for National Statistics will keep using experimental data for unemployment figures this month instead of the Labour Force Survey. The old series was suspended in October due to falling response rates.

Retail sales data due Friday may show a drop in volumes for December after an unusually strong boost in November. The British Retail Consortium said its measure of sales grew just 1.7% over the crucial Christmas shopping period, as consumers avoided big-ticket purchases like furniture or homeware.

“Retail sales seems to continue to be either flat or shrinking and that’s where the whole economy is at the moment as well,” Allas said. “We’re in a situation with not a lot of consumer confidence and not many green shoots that one can point to. We’re not growing very fast, but we haven’t conquered inflation yet.”

—With assistance from Andrew Atkinson, Harumi Ichikura, James Hirai and Tom Rees.

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