Written by Laith Khalaf, head of investment analysis, AJ Bell
Wherever you look, the green shoots of an inflation revival seem to be pushing up the turf. Private sector pay growth rose to 5.4% at the latest reading, and with minimum wage rising by 6.7% from April, that means more upward pressure on pay is in the post.
Also arriving in April courtesy of the new Chancellor will be an increase in employer National Insurance, at least some of which will find its way into higher consumer prices. In the United States the economy is still running warm and the potential for import tariffs and a crackdown on immigration under a Trump presidency threaten to bump up prices across the globe, prompting a significant change in inflation forecasts from the US central bank. Here in the UK inflation is also heading away from the 2% target, and the energy price cap is on the rise again. With the economy stalling, the watchword for 2025 is now stagflation.
As inflationary forces gather, the Bank of England isn’t going to be gung-ho about cutting interest rates. Nonetheless the fact three members of the MPC voted to cut bank rate by 0.25% is a dovish signal which markets will likely respond to. The market is still pricing in two further rate cuts next year, but this is a big climb down in the course of just twelve months. At the beginning of 2024, the market was expecting no fewer than 6 interest rate cuts in the course of the year; we got two. Bond yields have been climbing as investors price in the new monetary reality. The 2 year gilt is now yielding 4.5%, up from 3.6% in August. Seeing as base rate has fallen over that period, that shows just how much expectations of future rate cuts have been reined in.
It must be said there is currently a high degree of uncertainty over the future course of inflation, in part driven by a question mark over how much of Donald Trump’s rhetoric is going to find its way into policy, especially in terms of trade tariffs. No-one is expecting inflation to rise to double digits again, but sticky inflation still limits the capacity of the Bank of England to cut rates, even if it is only modestly above target. That’s going to keep borrowing costs elevated for companies, dampening the prospects for economic growth. It also lessens the chance of UK savers stepping outside the familiar walls of a cash savings account and investing in the UK stock market, which means we aren’t likely to see a big 2025 revival in the London Stock Exchange, at least not as a result of more positive retail investors flows.
Mortgage borrowers face a more extended period before they can look forward to substantially lower debt costs as a result of base rate staying higher for longer. Combined with higher taxes and rising prices, that spells a more constrained consumer, which puts additional downward pressure on economic growth and corporate profitability. The UK economic picture isn’t especially inspiring as we enter 2025, though we are by no means an outlier in that respect, especially if you look across to France and Germany, where growth in 2025 is forecast to be materially lower than on these shores. Misery loves company, they say.
