As the dust settles on the latest financial statistics, it’s clear that the UK’s economic future may be starting to find firmer ground, as evidenced by a discernible shift in inflation rates.
The annual inflation rate plummeted to 7.9% in June, a breath of fresh air amid the ongoing cost of living crisis, and a welcome deviation from the past seven months’ narrative.
Breaking down the inflation trend
While the UK inflation rate has been ebbing since its zenith of 11% last October, the decrease was sluggish, casting long shadows on monetary policy’s trajectory and raising mortgage rates.
The Bank of England’s hint at escalating rates further only exacerbates the concern. However, recent figures allude to a more promising trend – inflation finally appears to be on a definitive descent, tipping the scales towards a soft landing over a recession.
Supporting this optimistic narrative is a dive deeper into the consumer rate. The producer input prices witnessed a 2.7% decrease year on year in June, primarily due to dwindling oil prices which influence manufacturing and transportation costs.
Even the prices of imported food observed a 4-point reduction in June as compared to May. Although it takes a while for input prices to impact consumer prices, the effects are now evident and spreading.
Moreover, the core Consumer Price Index (CPI), an indicator of inflation within the consumer market excluding food and energy, also experienced a decline. June saw the annual core CPI rate fall from 7.1% to 6.9%, signaling a long-awaited shift in the right direction.
Future predictions amid unforeseen challenges
However, economic forecasts should never rest solely on monthly data, as they often vacillate. New disruptions lurk around the corner, with Russia blocking grain exports from the Black Sea and heatwaves in Southern Europe jeopardizing fruit and vegetable crops.
These inflation figures, although encouraging, merely represent a small batch of data amidst an ocean of variables.
The current decline in inflation brings forth pressing queries. How much further will the rates need to rise to maintain the downward pressure on inflation? How resilient will the economy prove to be in the face of prolonged high-interest rates?
Navigating these challenges, the Bank of England’s forecasting model – which predicted a drawn-out recession and a swift fall in inflation last November – falls under scrutiny.
Neither of these predictions came to fruition, resulting in the Bank of England’s governor, Andrew Bailey, acknowledging the need for “very big lessons to learn” when it comes to depending on forecasting models for policy decisions.
During this adjustment phase, current data developments should take precedence over analytical forecasting models, influencing not just policy decisions but also communication strategies. Unwarranted emphasis can negatively impact consumer confidence and business investment.
The two-year gilt rate is lingering around 5%, and even with an inflation rate of 7.9%, a Bank rate of 5% is still negative in real terms.
Considering the uncertainty around the pace of inflation’s decline, the Bank of England should aim for positive real rates at the two-year horizon until inflation reverts to its target. This may mean an extended period of a Bank rate plateauing around 5.5%.
Could the UK economy handle such rates without succumbing to a prolonged recession? The historical data is certainly reassuring.
