With the hit to real activity from high inflation having been and gone and mostly absorbed by government handouts and a real terms reduction in households’ pandemic savings, we no longer think there will be a peak-to-trough fall in real GDP of 2.0% this year. Instead, we think the drag from higher interest rates will trigger a smaller 1.0% decline in real GDP. This less downbeat activity outlook strengthens our conviction in our forecast that interest rates will soon rise from 4.00% now to 4.50% and stay there all year. In fact, there’s a growing risk that to generate the necessary economic weakness to reduce pay and core inflation to the levels consistent with the 2.0% inflation target, interest rates will have to stay at 4.50% well into 2024 too.
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