UK economy: Inflation will be higher in a year, companies predict

Businesses expect inflation to be higher in a year’s time and that wages growth will fall slowly, prompting analysts to predict that the Bank of England will lower interest rates only gradually.

According to a Bank survey of company decision-makers carried out in August, inflation is set to hit 2.6 per cent in a year, up from its present rate of 2.2 per cent. In July, firms had expected the rate in the year ahead to climb to 2.5 per cent.

Even in three years’ time, the rate of prices growth is tipped to be well above the Bank of England’s 2 per cent target at 2.7 per cent, the decision-maker panel research found.

Members of the central bank’s monetary policy committee, which sets the base rate of interest every six weeks or so, watch the survey closely to detect inflation, wage and employment trends. Persistently higher inflation expectations could feed into evidence that convinces a majority of MPC members to vote to keep interest rates on hold at the panel’s next meeting on September 19.

Central banks try to rein in higher inflation expectations when prices increase to prevent businesses and workers from continuously lifting prices and demanding higher wages, respectively. While interest rate rises are largely ineffective at taming inflation driven by external supply shocks, such as Russia’s invasion of Ukraine in 2022, they can dampen expectations for future prices growth.

Over the next year, companies anticipate scaling back pay settlements, although they are expected to remain high. Over the past 12 months, businesses on average lifted salaries by 5.7 per cent, while over the next 12 months they plan to raise them by an average of 4.1 per cent.

Similarly, businesses also intend to ease the degree of prices growth. Last month decision-makers said that they planned to raise prices on average by 3.4 per cent over the next year, down from an expectation of 3.7 per cent in the previous month.

“We see enough signals to expect wages growth and inflation to linger above target consistent rates for longer than the MPC expects,” Rob Wood, chief UK economist at Pantheon Macroeconomics, a consultancy, said. “We look for the MPC to cut interest rates again in November and February and then pause for six months as disinflation proceeds only gradually.”

Such a pace of loosening would disappoint financial markets, which expect one or two more cuts this year and for rates to drop to about3.5 per cent by the end next year. The MPC narrowly voted in favour of loosening borrowing costs by 25 basis points to 5 per cent at its last meeting on August 1. It was the first interest rate cut since March 2020.

Tomasz Wieladek, chief European economist at T Rowe Price, an investment firm, said: “The fact that CPI inflation expectations are sticky will keep the Bank of England cautious. The Bank will cut at quarterly pace in the next six to twelve months, a much slower pace than markets price today.”

Difficulties in finding staff receded last month, with 42 per cent of respondents telling the Bank that recruitment processes were about normal compared with 36 per cent in the previous month. In October 2021, only 11 per cent of firms said recruitment was normal.