The week ahead

Markets pendulum has swung too far

The Monetary Policy Committee (MPC) will almost certainly keep interest rates on hold at its next meeting on Thursday 9 May. The focus, therefore, will be on the new forecasts, any change in the minutes and the vote split. We expect the committee to start to lay the groundwork for rate cuts to start in the summer through its new forecasts, which will show inflation falling below 2% unless interest rates are cut. The risk is that the Bank chooses to start later and cut by less. In our opinion this would be a mistake.

Most committee members have shown little concern over the minor upside surprise to recent data releases. However, the vote will remain split, probably at 8-1, with the possibility of a 7-2.

Financial markets have gone from pricing in over five rate cuts at the start of February, to three by the time of the MPC meeting in mid-March and is only expecting 1.5 cuts now. There are some legitimate reasons for this pull back, but it looks like an over-reaction. As we’ve previously discussed, much of the dramatic change in rate expectations in the UK is spill over from the US. However, the UK is not the US and while keeping rates high makes sense for a booming US economy, the same cannot be said for the UK.

Admittedly, some members of the MPC are clearly still nervous about the outlook for services inflation and wage growth, which makes for a tricky communications challenge, so it is unlikely to send a strong signal about when rates will be cut on Thursday. But the previous guidance has left the door open to rate cuts. The MPC has made the point that interest rates don’t have to remain at 5.25% in order to be restrictive, which is Central Bank speak for we can cut interest rates without stimulating inflation.

The upshot is, we still expect the first interest rate cut to come in June, although this is now a close call. By then the MPC will have hard data confirming that inflation has fallen back to its 2% target and will have measured the impact of the near 10% increase in the national minimum wage in April. That should then be followed by two more cuts to leave rates at 4.5% by the end of the year

The risk is that the MPC delays and the first rate cut doesn’t come until August and that there are only two cuts this year.

Recession officially over

UK GDP data for Q1 2024 is likely to confirm the economy is on the path to recovery following a protracted period of stagnation brought about by high interest rates and inflation.

Monthly GDP data for January and February showed activity rebounded at the start of the year. Output expanded by 0.3% and 0.1% respectively.

Barring any revisions, the GDP release will only contain new information for March. We think output posted mild growth of 0.1%, which will deliver a quarterly gain of 0.4% for Q1 2024.

That gain would unwind the vast majority of the fall in GDP seen during the very mild and short-lived recession experienced in the second half of last year, leaving output just a touch below its level in Q2 2023.

We expect growth to be sustained over the coming quarters, though the recovery will be far from spectacular. Our forecast is for output to grow by 0.5% in 2024.

Sign up to our Real Economy communications for regular commentary and analysis from Tom on the changing economic landscape.