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Warnings of 3% Inflation Add to Bank of England’s Headache
(Bloomberg) -- The Bank of England could face a fresh battle to reassure investors of its commitment to interest rate cuts, with economists warning of inflation above 3% by the spring.
Official data on Wednesday is expected to show the consumer prices index sticking above target at 2.6% in December, the joint-highest in nine months. The BOE in November predicted a peak for this year of 2.8% in the third quarter, but price pressures have subsequently increased.
Energy bills are set to become a bigger driver of price growth again in 2025, as previous drops come out of the annual calculations and with the household price cap set to increase again in April. Bloomberg Economics estimates that household energy costs will add 0.5 percentage points to headline inflation in April even if they don’t rise further from their current level.
“We already thought inflation would be higher than the BOE forecasts this year, but the recent rise in energy prices means it’s likely to be higher still,” said Andrew Goodwin, chief UK economist at Oxford Economics. He expects a quarterly inflation peak of 3.3% in the third quarter.
Market Turbulence
It leaves Governor Andrew Bailey and his fellow rate-setters with another difficult trade off against a volatile global economic backdrop. They could become more forward-thinking, looking through what may be a temporary rise in inflation to focus on a growth outlook that is only weakened by gilt yields that have soared in recent days. Or the BOE could keep its gaze fixed on the worsening near-term inflation picture, and adopt a very cautious approach to cuts.
The pound tumbled below $1.22 during last week’s market turbulence, its lowest level since November 2023, threatening more upward pressure on inflation. With the UK caught in the middle of a global selloff in bonds, market expectations of BOE rate cuts this year slightly dropped to below the level that fully prices in two quarter-point moves.
“The broader question for the BOE is what they focus on in the coming year if inflation is above target and unemployment is rising,” said Dan Hanson, chief UK economist at Bloomberg Economics.
“The recent inflation episode taught us that inflation expectations can drift,” he said. “That means the Bank is unlikely to support the economy as much as it might have done had it been confronted with the same trade-off prior to the pandemic. The upshot is that it’ll be hard for it to shift away from gradual cuts.”
Deutsche Bank chief UK economist Sanjay Raja also expects higher prices at the petrol pump and for gas and electricity to boost inflation above 3%.
“Our biggest worry from a BOE perspective, is that rising inflation to start the year pushes inflation expectations higher too,” he said. “We’re already seeing higher energy and food prices seep into the consumers’ minds and this, we think, could cause some consternation around the policy path.”
Meanwhile, monthly GDP figures on Thursday will reveal more about a slowdown in growth since Labour entered power last July. Forecasters expect output to rise 0.2% in November, potentially a reprieve for Prime Minister Keir Starmer after a run of poor data.
--With assistance from Eamon Akil Farhat.