Written by Rob Morgan, Chief Investment Analyst at Charles Stanley
The stubbornness of services inflation driven by strong wage rises and heightened uncertainty surrounding the outlook were enough for Bank of England policymakers to reach for the interest rate pause button today.
Business Budget response the critical factor for inflation in 2025
With wage inflation remaining high, feeding into services costs, and a reacceleration of energy prices, the BoE is wary of cutting interest rates too much too soon, especially now fiscal policies revealed in the Budget could add fuel to the inflationary fire into the New Year.
There’s a lot to monitor for BoE economists, not least the trade-offs businesses will be making between growth, employment and pricing in response to the Budget.
The additional costs for employers in terms of higher national insurance and minimum wages looks set to reinforce the trend of escalating costs in the services sector. Although employers might take some of the hit with lower corporate margins, much of the impact could take the form of higher consumer prices.
The BoE will be carefully monitoring the corporate response, which could vary across different industries and individual businesses. Given the uncertainty it’s no surprise it wants to place more emphasis on a gradual approach focused on developing data rather than make any assumptions.
Further afield, there are inflationary concerns surrounding what Donald Trump’s reprise as US President might mean for global supply chains. Should he look to expand his tariff approach there could be a significant inflationary impact on global trade.
Interest rates will continue to fall but trajectory will be shallow
Previously, Governor Bailey stated that “interest rates are going to come down. I’m optimistic on that front”. This much still holds true, but when and by how much is very much in doubt.
An unusually broad spectrum of outcomes are in play, presenting a quandary for the BoE. On the one hand big government spending plans and additional costs for businesses could stoke inflationary pressures. On the other, it must be alert to the Budget weighing on confidence and dampening consumer and business activity.
As things stand there are too few signs of structural inflation problems receding for sizable or rapid cuts to interest rates to be made. This week’s blowout wages numbers and stubborn services inflation highlight the challenges of bottling up the inflation genie for good. Combined with the uncertain Budget impact yet to play out, it’s going to be hard for policymakers to be convinced to cut rates aggressively.
It remains highly likely the Bank will continue to follow its data dependent path and cut rates in the New Year, perhaps as early as its first meeting in February, but we expect only a gradual withdrawal of more restrictive policy over the course of 2025.
