Interview
Why the U.K.’s high inflation has global implications
- UK inflation is anticipated to begin falling, driven by declining energy and core goods prices, though core inflation is expected to remain near 6% by year-end, sustained by strong services demand and wage growth.
- The UK faces a confluence of shocks including excess demand, tight labor markets constrained by immigration changes and Brexit, and energy supply issues, creating a higher probability of recession estimated at 40% over the next year.
- The Bank of England is projected to implement a 25 basis point rate hike immediately, followed by two additional steps to a terminal rate of 5.75% by November, which is positioned above rates of other major central banks.
- Fiscal policy is forecast to shift from supportive to a drag on growth, deducting approximately 0.5 percentage points this year and rising to just over 1 percentage point in 2024, further complicated by fiscal costs from higher interest bills and quantitative tightening.
- UK consumption is expected to remain stagnant with growth forecast at 0.3% this year and 0.7% next year, supported by pandemic savings but hindered by high inflation and rising mortgage payments.
- Effective mortgage rates are projected to rise to 4.5% by the end of 2024, with the bulk of the resulting drag on the housing market still to materialize.
- Yield market expectations include 10-year gilt yields peaking near 4.5% in Q3 of the current hiking cycle before settling around 4% in the steady state, with European yields also expected to remain elevated.
- Sterling is forecast to appreciate over a 12-month horizon, reaching 1.33 against the US dollar and 2.84 against the euro, supported by the potential for UK rates to rise while the Fed and ECB pause or end their cycles.
- While global bond markets are expected to react to UK inflation, the impact has been muted as markets view the situation as idiosyncratic; a resolution to UK inflation issues is expected to alleviate global runaway inflation concerns.
- Despite a base case scenario that avoids recession, the UK economy is expected to see barely positive growth in the second half of the year with a slight pickup in 2024, as the probability of recession remains twice that of the US.