‘Inflation in the UK will be too low for the next three years’, top economists say

Inflation in the UK “will be too low for the next three years”, prompting the Bank of England to slash interest rates, according to top economics consultancy Capital Economics.

New research from the consultancy projects inflation to fall below the 2% target next month, when the new energy price cap comes into effect. That would bring the UK’s inflation rate below 2% sooner than in the US or Eurozone.

Capital’s economists then project inflation to fall to as low as 0.5% later this year, and to stay below the 2% target for all of 2025 and 2026.

Capital said: “After having been too high for the past three years, inflation in the UK will be too low for the next three years, and much lower than in the US and the euro-zone.” It added that this could lead to a quite rapid change in the Bank of England’s monetary policy.

While the Bank of England expects inflation to fall below 2% this year, it sees the pace of price rises remaining above 2% for much of this period.

Given the fall in inflation, the Capital team said they believe the Bank will slash rates dramatically in 2024 and 2025, with rates falling to just 3% by next year. That’s a much sharper fall than City traders are predicting, as markets still imply that rates will be 3.75% by that point.

While much of the concern in recent years has been high inflation, the Bank of England’s target means that it also takes action when inflation is too low.

The fall in inflation and interest rates will lead to wider economic improvement, Capital said, as “lower inflation and lower interest rates will also contribute to a stronger economic recovery than most expect”. Capital had previously expected 2024 to be a year of stagnation, but now see GDP growing by 0.5% this year.

Projections from KPMG today also showed inflation falling to the 2% target in the first half of the year, though they see the rate rising to slightly above 2% again.

They added that “there are risks to the outlook, which could cause inflation to remain higher,” citing events in the Red Sea as a particular cause of uncertainty.