UK Weekly: Revising down our Bank Rate forecast to 3.00%

There were two key developments for the inflation outlook this week. First, some of the upside risk to CPI inflation posed by the conflict in the Middle East and higher energy prices has subsided. After the price of Brent oil ended the UK business day on Monday at $77 per barrel (pb), the limited Iranian retaliation and the announcement by President Trump of a ceasefire led to a 10% decline to around $68pb by Tuesday morning. Prices have largely moved sideways since.

Admittedly, the conflict could reignite, leading to a resurgence in energy prices. As we warned last week, with inflation expectations already elevated and CPI inflation likely to spend the rest of this year around 3.5%, higher energy prices would raise the chances of second-round effects. (See here.) So the risk that the Bank of England slows the pace of interest rate cuts from one 25 basis points (bps) cut per quarter later this year cannot be ruled out.

That said, given the drop back in energy prices and the relatively muted reaction to fears of a ceasefire violation on Tuesday, the chances of a sustained rise in energy prices have fallen. (See here.)

The second key development for the inflation outlook was the significant drop in the services PMI output prices balance in June. (See here.) As recently as April, the balance was consistent with services CPI inflation of around 5.0% in six months’ time. (See Chart 1.) It now points to services inflation ending the year at around 3.0%, which is consistent with overall CPI inflation returning to the 2.0% target.

​While we expect the clear loosening in the labour market to eventually weigh on wage growth (see here), we are yet to see much evidence of that happening. So June’s PMI release leaves us more confident that weaker activity will continue to feed through into lower domestic inflation.

This lends support to our forecast that CPI inflation will return to the 2.0% target next year and spend most of 2027 below it. That would mean inflation is lower than the Bank of England and the consensus forecasts.

As a result, and as we will set out in our forthcoming UK Economic Outlook,we now expect the Bank to continue to cut Bank Rate by 25bps a quarter from 4.25% now until they reach 3.00% in 2026. That would be further than our previous forecast and current market pricing of 3.50%. (See Chart 2.) (Clients can explore all our forecasts on our interactive UK Data Dashboard.)

The week ahead

Next Friday marks the one-year anniversary of the government’s election victory. We’ll be discussing what it’s got right, what it’s got wrong and what’s next at in-person Roundtables at our London office on Tuesday. (Register for one of the last few places here.) Alternatively, we’ll be holding an online briefing on Thursday at 3pm BST. (Register here.)

Data Previews

Mon. 30^th Jun. – GDP (Q1, Final Estimate)

More evidence of consumer caution

There is more scepticism than usual about the first estimate of a 0.7% q/q rise in Q1 as it jars with the weak survey data, low levels of business and consumer confidence, and the still-restrictive level of interest rates. But for now, a downward revision looks unlikely, since the biggest revisions to GDP estimates tend to come through later. GDP growth in Q1 2024 was also well above that implied by the surveys, yet it was revised up in the second estimate.  

We don’t expect the release to change the picture that surges in business investment and net exports were the main drivers of GDP growth in Q1 – sources of growth that are unlikely to be sustained.

The new news on household income may provide further evidence that households were cautious and held back from spending much more in Q1, as jobs growth and consumer confidence weakened. We estimate that real household disposable income rose by 0.5% q/q in Q1, outpacing the 0.2% q/q gain in real consumption, and that the saving ratio remained elevated at around 12.0%. (See Chart 3.)

Economic Diary & Forecasts