Jan
2025
Inflation concerns add to pressure on government borrowing: Experts respond
DIY Investor
15 January 2025
Inflation concerns add to pressure on government borrowing – but BoE rate cuts could provide ray of hope – Rob Morgan, Chief Investment Analyst at Charles Stanley
The UK has been experiencing an unenviable mix of stubborn inflation, driven by services prices and energy costs, and economic stagnation – or ‘stagflation’. This has been reflected in the weak performance of gilts in recent weeks as markets fret about the persistence of globally and locally generated inflation pressures, combined with the government’s spending and borrowing plans and a lacklustre growth picture.
The recent spike in gilt yields, the benchmark for government borrowing costs, will have set alarm bells ringing in the Treasury. Yet Chancellor Reeves may be offered a ray of hope. With inflation falling nearer to target and financial conditions posing downside risks for the UK economy, the Bank of England should now be able to deliver greater interest rate cuts than has been discounted. This stands to ease the pressure on consumers and businesses later this year and may help take the heat out of spiralling government debt costs.
What does today’s inflation data tell us?
Today’s inflation data shows that after receding for much of 2024, average price rises moved slightly higher into the year end as CPI recorded an annual increase of 2.5% in December, which followed an increase of 2.6% in November – ahead of the Bank of England’s 2% target but still consistent of a wider trend of easing inflationary pressure.
Encouragingly, core inflation, which strips out volatile elements such as fuel and food, fell back to 3.2% in December from 3.5% a month earlier. Services inflation, which has been the hardest nut to crack for the BoE, dropped to 4.4% from 5.0% and will be of particular interest to policymakers in Threadneedle Street as they eye further possible rate cuts. Services inflation driven by wage rises has been one of the main barriers to easing monetary policy further.
When will interest rates be cut further?
Fiscal policies unveiled in the Budget, notably the increase to employer national insurance, stand to add to upward pressure on prices and mean services inflation may be hard to flush out of the system owing to its typically higher labour intensity.
Other factors could also conspire against there being more than a couple of interest rate cuts this year. Major retailers have warned that food prices may resume an upward trajectory, and a recent increase in the previously subdued oil price could herald a further inflationary pulse on top of the expected impact of Donald Trump’s reprise as US President. There are concerns that should Trump look to implement his tariff-led approach there could be a significant impact on the costs of global trade.
However, with just two cuts last year and economic pressures mounting, we believe a balance of policymakers will decide it is appropriate to take a further 0.25% slice off interest rates from 4.75% to 4.5% at the next meeting in February. If anything, the recent tightening in financial conditions, which pose clear downside risks to the UK economic outlook, reinforce the case for BoE easing in the spring too. Further reassuring inflation numbers would also serve to point the committee in that direction.
What does it mean for borrowers and savers?
Many households and businesses will be hoping for significantly lower interest rates to reduce borrowing costs. Owing to the uncertain trajectory of inflation the best they can hope for is a slow and steady downward trend, but there is a good chance market expectations will shift to more than a couple of cuts for 2025 which could provide a bit of relief in coming months.
Meanwhile, the interest rate picture remains positive for savers with the best easy access rates still north of 4.5%. However, this inflation-beating rate of return is likely to narrow over time as base rate moves lower. It may therefore be a good time to consider a fixed rate if you are happy to lock your money away because inflation and interest rate expectations may now fall back a little. A rate of around 4.5% is currently achievable for a one-year fixed term.
Ben Thompson, Deputy CEO at Mortgage Advice Bureau, said:
“It’s been clear for a few months now that inflation would remain slightly above the Bank of England’s targets. Today’s reading reinforces the view that this trend may continue into the new year.
“For buyers, this means that, at least in the short term, borrowing costs are likely to remain broadly where they are. As we move into the spring and summer months, inflation will hopefully slow, allowing the Bank of England to resume its rate-cutting cycle. However, now is not the time for buyers to adopt a wait-and-see approach. Seeking advice, getting mortgage ready by ensuring all of your paperwork is in order, and even securing a mortgage in principle can make all the difference when it comes to buying.”
Paresh Raja, CEO of Market Financial Solutions, said: “This is good news, and comes despite predictions of another small rise. However, the fact that inflation is proving sticky, remaining above 2%, is still likely to fuel arguments that the Bank of England will, or should, delay cutting the base rate. But I believe it’s still too early to make definitive predictions. We need to consider the broader context: inflation fluctuates by a few percentage points each month, and following significant fiscal events like the Autumn Budget and the lead-up to the busy Christmas period, inflation hovering above the 2% target was always a possibility.
“The key focus now shouldn’t be on whether the BoE cuts the base rate at its next meeting or even the one after that. This attitude actually creates hesitancy, encouraging a ‘wait and see’ approach. Instead, as an industry, we need to continue adapting to the current lending landscape and ensure that brokers and borrowers have the support they need to execute their plans effectively. While we may not see a return to lower rates as quickly as some might have hoped should inflation remain above 2%, the market has demonstrated resilience through far tougher conditions in recent years, which is important to keep in mind.
“We’ve already observed positive signs of growth in the early months of this year, particularly when it comes to house prices and buyer demand. So, if lenders can tailor their offerings to meet their clients’ needs, there’s every reason to remain optimistic about the outlook for the months ahead.”
UK inflation cools down, paving way for rate cut in February
Lale Akoner, Global Market Analyst at investment platform eToro, says “UK inflation for December came lower than our expectations, at 2.5% in December, down from 2.6% in November. Most importantly for the BoE, core CPI fell and services inflation cooled down to lowest since March 2022.
“This will be a relief for the markets where there has been an unprecedented sell-off in the bond markets, leading to higher interest rates, and subsequent tightening in financial conditions. We continue to expect that a rate cut in February is still odds-on.”
Paul Noble, CEO of Chetwood Bank, said: “Some good news to start the year for Britons. Many will have approached today’s result with some apprehension, but 2025 can begin on a positive note despite the uncertainty.”
“The economic environment is still nowhere near stable, with inflation yo-yoing back and forth from the 2% target. The uncertainty surrounding the budget has not dissipated, but these figures will help to calm nerves nationwide, at least in the short term. However, the spectre of public sector wage increases will keep experts guessing as the year goes on, and the Bank of England will be watching CPI closely as they consider the timing of their next rate change.
“The one thing that consumers can control is their financial future, and it’s more important than ever to be proactive in seeking out the best savings opportunities. Financial institutions must support them by providing accessible solutions and products that add real value.”
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