As the dark days of winter recede and Spring is sprung, central bankers have been scurrying out of their burrows to share the good news that the time of high interest rates is nearing its end. And, waiting just over the horizon is a warm glow of interest rate cuts. One after another, the US Federal Reserve’s Jay Powell, the ECB’s Christine Lagarde and the Bank of England’s Andrew Bailey, have opened up on how the Fed “is not far” from cutting rates, ECB officials back a June rate cut but are “keeping the door open for April,” and UK investor’s bets on rate cuts this year are “not unreasonable.123” All welcome news. For the moment, however, we will focus our attention, at home, on the UK.
On 14 February, Valentine’s Day in the UK, the Office for National Statistics reported that the Consumer Price Index (CPI) rose by 4.0% in the 12 months to January 2024, holding steady at the same rate as in December 2023. That rate, 4.0%, is still above the BoE’s target, 2%, but it’s a dramatic improvement on the 10.1% rate of a year ago. Even before that data was published Governor Bailey speaking in February, shortly after a BoE meeting, said “inflation could ease to its 2% target within a few months.” It’s a view we share. It could arrive as soon as April, and potentially fall below 2%.
Supporting that prognosis, we’d cite a number of forthcoming events. From 1 April 2024 (to 30 June) OFGEM’s price cap will fall 12%; the price for energy a typical household, who use electricity and gas and pays by Direct Debit, will go down to £1,690 per year. This is £238 per year lower than the price cap set between 1 January to 31 March 2024 (£1,928)4. A similar fall is not out of the question in July. Staying with energy, the 6 March Budget saw the Chancellor freeze fuel duty again for another 12 months5. Duty is charged at 52.95p a litre, an amount that was cut by 5p in 2022 by the then chancellor, Rishi Sunak, after prices spiked following Russia’s invasion of Ukraine.
Taking the temperature with business heads
Hot on the heels of the Budget, the BoE released its Decision Maker Panel survey of Chief Financial Officers from small, medium and large UK businesses (firms across the whole economy, not just consumer-facing), on 7 March6. A temperature check taken between 2 and 16 February, the 2,373 influential heads of business respondents, said they expected their output price inflation to decline by 1.1 percentage points over the next 12 months (based on three-month averages).
Annual wage growth was put at 6.7% in the three months to February, down 0.1 percentage point from the three months to January. More importantly though, the firms surveyed said they expected their wage growth to decline by 1.5 percentage points over the next 12 months (based on three-month averages). A slight fly in the ointment was the expected year-ahead wage growth figure to still be unchanged at 5.2% (on a three-month-moving-average basis) something the BoE is tracking but the direction of travel thereafter should be down. Before the COVID-19 pandemic, when inflation was close to the BoE’s 2% target, annual growth in basic pay was around 3%.
Annual employment growth of 2.3% was reported in the three months to February, down on the 2.4% reported in the three months to January. Expected year-ahead employment growth was 1.6% in the three months to February, down 0.1 percentage points from the three months to January. The survey results align with other signs that Britain’s job market is cooling, a development which should broadly ease pressure on wage growth and provide some comfort to BoE policymakers.
A few sticky issues
There are some exceptions. A rise in the National Living Wage (NLW) by 9.8%, in April, serves as a stimulus and in the battle to retain retail staff a slew of supermarkets including Tesco, Co Op, Sainsbury’s, Asda, Aldi, Lidl, M&S and Waitrose, have all announced salary increases of above the NLW level 7,8,9. The impact of these large, low-wage employers could push CPI inflation back to above 2.0% towards the end of the year but ahead of then inflation should drop.
The heavily trailed 2p cut in national insurance could have been viewed as inflationary also but with a number of small tax increases on items such as vaping, tobacco and holiday home lets amongst other things, the overall impact can be broadly assessed as neutral10.
Headlines services inflation has been another slightly sticky issue. At 6.5% in January, it has come down only slightly from its peak of 7.4% in July 2023. As the cost of services/bills index-linked to inflation, such as mobile phone contracts, some rents and property insurance charges, rise less than last year, however, this figure too should start to decline more meaningfully.
Maybe it is Spring and the hope and renewal it unleashes, or just good old-fashioned analysis based on intense research, but we are of the opinion that inflation is now headed decisively lower. As a result, we have sold out of all our inflation-linked gilts and replaced them with nominal bonds. We like the duration component of the inflation-linked bonds but not the inflation-linked component, as we don’t believe the expected fall in inflation is fully priced in.
