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UK inflation expected to drop below double digits — but interest rates still set to rise

City economists forecast a cooling in March inflation rate

inflation  A shopper puts fruit in her basket in a supermarket in London, Wednesday, Aug. 17, 2022. The UK inflation rate has hit 10.1% in the year to July, new figures from the Office for National Statistics have shown. The figure is up from 9.4% in June and is at its highest level in more than 40 years. (AP Photo/Frank Augstein)
Rising food prices led to inflation jumping to 10.4% earlier this year. Photo: Frank Augstein/AP (ASSOCIATED PRESS)

UK inflation is expected to have dropped below double digits in March, which should give hope that the Bank of England (BoE) would refrain from raising its key rate again but markets have already priced in another hike.

Inflation is the increase in the price of something over time. If a bottle of milk costs £1 but £1.05 a year later, then annual milk inflation is 5%.

City economists forecast a cooling in the UK’s March inflation rate when official figures are released on Wednesday, with expectations for a reading of 9.8% — the first single-digit figure since August last year.

“After February's inflation surprise, we expect, price momentum to regain its downward footing. A reversal of very strong clothing inflation alongside an unwind of some unusually strong price increases, we think, will push CPI and RPI lower, with the former dropping below double digits for the first time in six months,” Deutsche Bank senior economist Sanjay Raja said.

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Read more: How Bank of England plans to prevent SVB-like bank runs

“What to expect? We see headline CPI slowing to 9.73% y-o-y. Core CPI, we expect, will drop to 5.85% y-o-y. Services CPI, we estimate, will drop to 6.3% y-o-y. And headline RPI, we think, will edge down to 13.29% y-o-y. Risks to our forecasts, on all fronts, are skewed to the upside.”

However, even if inflation came down in March, UK households will have felt no difference as prices still remain high. A drop in the annualised rate of growth just means that prices aren’t rising as fast, not necessarily that prices are falling.

Analysis by consumer group Which? shows year-on-year price increases for UK groceries reached 17.5%in the four weeks to 19 March, while the price of some food basics have increased by up to 80%.

Isabel Albarran, investment officer at Close Brothers Asset Management, factoring in the jump in headline pay growth and the slow in private sector pay, said: “Following such substantial price increases last year, we believe it’s highly likely we will see inflation figures heading lower tomorrow. With energy prices expected to continue to fall this year, we expect to see inflation to follow suit, although it will take longer for other price declines to come through, particularly in retail utility pricing.”

“Thanks to energy prices and additional measures from the budget, overall GDP forecasts have been revised higher in recent months, with growing hope that the UK may narrowly avoid a recession. For the Bank of England, the key factor to watch remains the labour market.

Read more: UK inflation is 'bad luck', says Bank of England's chief economist

“Headline pay growth jumped this morning and the labour market undoubtedly remains tight, reducing the likelihood of imminent rate cuts from the Bank of England.

“However, private sector pay actually slowed, participation is rising, and forward looking indicators such as business attitudes towards hiring are cooling, which should ease pressure on wages in the months ahead.”

In March, the BoE raised the UK interest rates by 0.25 basis points to 4.25% to combat double-digit inflation.

This was the 11th time in a row, in less than 18 months, that the central bank has increased rates, making borrowing costs higher despite the cost of living crisis.

It lifted UK interest rates to their highest since October 2008, early in the financial crisis, when the Bank Rate stood at 4.5%.

At the March meeting, the BoE said there were signs inflation, last reported at 10.4% in February, was peaking and would probably fade fast, prompting speculation for a pause. However, it kept the door open for more tightening if needed.

BoE policymaker Silvana Tenreyro said past interest rate rises would take time to bear down on inflation, and that it was important not to over-adjust policy while the impact of these past rate rises was feeding through.

"We need to be patient," she said at a panel discussion hosted by the International Monetary Fund in Washington on Friday. "We don't want to get burned. We don't want to get an ice-cold shower."

Fiona Cincotta, senior financial markets analyst at City Index, said that inflationary pressures will probably result in yet another interest rate hike.

“Average earnings, including bonuses, rose 6.6% in the three months to February, in line with the previous month and defying expectations of a slowdown to 6.2%, which could leave the BoE little choice but to keep hiking rates in its fight against inflation which is still five times the target 2% level.”

Read more: Bank of England expects inflation to fall as pound hits 10-month high

Steven Bell, chief economist for EMEA at Columbia Threadneedle Investments, also sees the BoE deciding yet again to raise rates.

“We believe UK interest rates are headed higher also. Inflation remains far too high although wage inflation in the private sector has slowed,” he said.

Even with mixed signals from the economic data, markets have already priced in another rate hike.

“Economic data released between now and the Bank of England’s May meeting hold the key to whether the central bank will lift rates again. We think the BoE will have reason to pause but markets disagree, having priced more than an 80% chance of another hike,” Ana Andrade from Bloomberg Economics, said.

The latest inflation figures will come out this Wednesday at 7am in London, with the Bank of England’s next rate decision taking place on 11 May around noon.

Watch: How does inflation affect interest rates?

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