Oliver Mangan: UK economy facing into significant headwinds

The Bank of England is anticipating a sharp slowdown in consumer spending

Mon, 14 Feb, 2022 - 13:09

The Bank of England was quite downbeat on the prospects for the UK economy in its February monetary policy report.

It expects the combination of tax hikes, high inflation — especially higher energy prices — as well as a tightening of monetary policy that will see mortgage rates rise, will deliver a major blow to real household disposable income, which could decline by around 2% in 2022 and a further 0.5% next year.

While a partial rundown of household savings that were accumulated over the past two years may cushion the blow somewhat, the Bank of England is anticipating a sharp slowdown in consumer spending. Brexit is also acting as a headwind for UK exports.

As a result, the Bank of England is forecasting that UK GDP growth will decline to below trend, at 1.25% in 2023 and 1% in 2024, with the country’s unemployment rate climbing from 4% to 5% in two years’ time. It expects inflation will fall comfortably below target by 2024.

The UK central bank’s forecasts are based on interest rates getting to 1.25% by the end of 2022 and a 1.5% peak in 2023. Markets are looking for a 50 basis point hike in March and 25 basis points at each of the next three meetings, taking rates to 1.75% by August, before one more hike by mid-2023.

Irish inflation will persist as Lane plays down ECB response

It may be that UK markets are being overly influenced by the US. The US economy is expected to grow by 4% this year and 2.5% in 2023.

Notably, the chair of the Federal Reserve has warned that the fact the US economy is stronger, labour market tighter and inflation much higher than in the previous rate hike cycles has important implications for the future course of US monetary policy.

Rates topped out at the 2.25%-2.5% range in the last cycle. One would expect US rates to get to at least this level in this cycle.

We will get updated ECB macro forecasts next month. The core CPI inflation rate is at 2.5%, much lower than the 6% rate in the US and 4.2% in the UK. The labour market is not as tight, with the unemployment rate at 7% and no sign of the wage inflation that we are seeing in the US and UK.

Markets, though, now expect 25 basis point hikes from the ECB in both September and December. This looks to be the upper limit of what the ECB is likely to do this year, with just one increase possible.

With core inflation not far above target, and a track record of very low inflation in the eurozone for more than a decade, as well as subdued wage inflation, the ECB does not need to be overly aggressive in terms of the pace of rate increases.