What lies ahead for interest rates?

By Richard Morton, Head of Banking & Finance at Blacks Solicitors

On 1 February, The Bank of England (BoE) announced the decision to keep interest rates steady at 5.25%, marking the fourth consecutive hold. 

Despite the improving annual inflation rate, maintaining the current rate is seen as a positive outcome compared to recent months. However, the market and one member of the BoE’s Monetary Policy Committee (MPC) are advocating for rate cuts sooner rather than later. 

What this means 

Inflation is a term that we use to gauge the rate at which prices for specific goods and services rise in an economy. The reported inflation rate varies depending on the items included in the calculations, such as gas, clothing, housing costs, and council tax (amongst many others). There are various ways of cutting the numbers in an alphabet soup of acronyms such as RPI, CPI and CPIH. Different measures include different things.

The Consumer Prices Index (CPI) is the measure used by the UK government to assess inflation, with the BoE tasked to keep it at 2%. The CPI recently increased by 4% in the 12 months ending December 2023, up from 3.9% in November but down from the recent peak of 11.1% in October 2022, the highest annual inflation rate since 1981.

When politicians talk about inflation “going down” what they generally mean is that “prices have stopped going up by as much, but are still going up”. Having said this, some things will actually reduce in price (like utilities are expected to do) but a white sliced loaf is likely to stay at £1.50. Higher prices for some things are here to stay even if the thing that caused the price shock may have dissipated.  

Looking ahead

Despite the apparent positive aspect of reducing the inflation rate from 11.1% to 4%, meeting Rishi Sunak’s commitment to halve inflation, it still stands at twice the target. BoE Governor Bailey continues to convey a commitment to maintaining higher interest rates for an extended period to control inflation, underscoring the BoE’s assertion that further significant progress is yet to be made before a rate cut actually happens. 

The BoE’s own forecasts expect CPI inflation to briefly hit the 2% target in Q2 2024 before rising in Q3 and Q4, influenced by changes in direct energy prices. Based on the MPC’s latest projection with a lower bank rate, CPI inflation is estimated to be around 2.75% by year-end. Despite increasing economic slack, persistent domestic inflationary pressures are projected to keep inflation above the target for most of the forecast period, reaching 2.3% in two years and 1.9% in three years.

The Bank of England is trying to avoid creating the perception that the inflation challenge is fully under control, as this might inadvertently encourage inflation to escalate, leading to more enduring issues in the long term.

In December 2021, the BoE interest rate stood at a mere 0.25%. Since then, it has been raised 14 times to its current level of 5.25% to address inflation concerns. As many homeowners exit fixed-rate mortgage deals, this mechanism is causing significant challenges, adding to uncertainties for both individuals and businesses and affecting the “real economy.”

One of the advantages of using the CPI inflation measure is that it allows international comparison and, whilst the UK seemed to be getting the worst of things a few months ago, the latest available figures in December showed that the UK is doing slightly better than France and slightly worse than the US and Germany in squashing inflation.

While wage growth remains a concern, it is slowing and unemployment is expected to rise. Overall GDP performance in 2023 was weak but is expected to edge up in 2024, with tough challenges in specific sectors.

Looking ahead, the UK is expected to follow the European trend, experiencing unremarkable growth with easing inflation. Whilst this is all slim pickings, it may provide the central bank with an opportunity to lower rates, possibly in the summer. We are not yet out of the woods yet but it looks like we will be heading in the right direction; we can at least put our shoes on.

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