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Higher interest rates yet to take a big toll on activity

We’ve been surprised that the rise in Bank Rate from 0.10% in November 2021 to 4.25% hasn’t triggered a contraction in GDP at the start of this year. Indeed, while higher interest rates were a further drag on net mortgage lending in March, the performance of other interest rate sensitive areas hasn’t been very weak and in fact has recently improved. It may be that the boost to nominal household incomes from fast wage growth and government handouts is supporting activity. Or that the fading drag on real incomes from inflation has driven the recent improvement. Either way, the economy’s resilience combined with the stickiness of both core inflation and price/wage expectations raises the chances that interest rates will need to rise further than our forecast of a peak of 4.50% and/or stay higher for longer to generate the economic weakness required to reduce inflation from over 10% to the 2% target.

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