Price growth set to almost double yet interest rate hike uncertain
Price growth could jump to as high as five per cent within months, economists have said, leaving the outlook for interest rates more uncertain.
Top City economists said they expected inflation to rise to nearly double the rate seen just before war in the Middle East broke out, leaving the Bank of England with a more difficult decision to make on whether to hike interest rates.
On Wednesday morning, the Office for National Statistics said inflation in the year to February was three per cent, in line with market expectations and flat on the month before.
Due to the energy price shock caused by a blocking of trade flows across the Strait of Hormuz, economists have warned that inflation could hit five per cent around autumn.
Capital Economics deputy chief UK economist said a “baseline” scenario at the consultancy was that inflation reached 4.6 per cent in September this year in part due to higher petrol and diesel prices.
An “indirect boost from businesses passing on some of their energy costs” could also add to pressures.
WPI Strategy economist said five per cent inflation was “very plausible”, though added that a weakened labour market should prevent price growth from jumping as high as it did after Russia’s full-scale invasion of Ukraine in 2022.
Analysts have suggested that “second-round effect” impacts will be lessened because employees are likely to have less bargaining power over bosses in negotiating higher pay, which would in turn add to costs on firms that are passed onto consumers.
“That means the main effect of higher energy prices now is more likely to be weaker growth and higher unemployment, with the rise in inflation proving transitory,” Beck said.
“But either way, the economy will still take a hit, unless the conflict ends quickly and in a way that genuinely eases geopolitical tensions.”
Price outlook leads to interest rate clash
Economists are now sparring on where interest rates will be by the end of the year.
Traders have suggested that there could be three interest rate hikes this year.
ING’s James Smith said live pricing “looks extreme” and that expectations may be “distorted” due to poor liquidity levels in markets.
Suren Thiru, the chief economist at the UK’s accountancy lobby group, said predictions of a rate rise had been “dramatically overstated as the damage to growth from the conflict will likely lower inflation over time”.
However, Thomas Pugh, chief economist at the consultancy RSM said a rise in inflation over the coming months could “force the Bank to raise rates”.
“The longer energy prices stay high, the more likely second-round effects are to emerge and inflation expectations are to become further de-anchored,” Pugh said.
“Inflation may remain elevated through most of 2027 as indirect effects start to come into play.
“Inflation should then fall rapidly later in 2027 as those energy effects unwind and a larger output gap from a weaker economy weighs on inflation.”
Economists at JP Morgan have also suggested that interest rate hikes are on the horizon.