Interest rates could ‘hit a peak of 4%’ – Capital Economics

The Bank of England could raise the base rate from 1.75% to a peak of 4% next year, according to a leading economic consultancy.

A “potentially huge fiscal expansion” will force the Bank of England to raise interest rates to a peak of 4% next year, Capital Economics’ revised forecasts reveal.

The economic consultancy initially expected interest rates to hit 3%, but said its revision stemmed from the government’s energy price guarantee to freeze utility prices for the next two years.

Initially, he lowered his short-term inflation forecast and said the expected recession “will be less deep”, but warned that this would lead to higher inflation in the future as well as lower interest rates. higher.

Those consequences have now been factored into its revised forecast, along with reports this week that the government is set to hold a ‘mini-budget’ which could see new Prime Minister Liz Truss reverse the April hike. National Insurance and the company’s planned rise next April. tax.

Up to 2.25% by next Thursday

Paul Dales, chief UK economist at Capital Economics, said: “The utility price freeze means that instead of peaking at 14.5% in January, CPI inflation is likely to peak around 10.5% in October or November and will then fall a little faster. Next year.

“But while it is possible that reducing the national insurance tax and not increasing corporation tax will stimulate investment and increase aggregate supply, we believe that the increase in aggregate demand due to the utility price freeze will be greater. As such, we have added around 0.5 percentage points to our forecast for core inflation in 2023. So while our new forecast for CPI inflation is weaker in the near term, it is higher in the future.

“It is this coming surge in inflation that has convinced us that the Bank should raise interest rates to 4%. We now assume that the Bank will raise interest rates by 50 basis points (bps) at next Thursday’s meeting (from 1.75% to 2.25%) and by 50 bps at the November meetings (to 2 .75 percent), December (to 3.25 percent) and February (to 3.75 percent) before a smaller 25 basis point hike next March (to 4 percent).

However, Dales added that the risk to his rate forecast centers on the labor market. If it loosens sooner than expected, then perhaps the Bank Rate will peak at 3.25-3.75%.

“But also, if the labor market is taking longer to ease, perhaps because labor supply remains exceptionally weak, or if a given weakening in activity has less influence at lower on inflation than in the past, the Bank may need to raise interest rates above 4% to ease domestic pressures,” he said.

Dales concluded: “A rate hike to 4% would take rates well above our long-term neutral rate estimate of 2.5%. As a result, rates of 4% will likely weigh on GDP growth in 2024, reinforce our belief that there will be a significant decline in house prices and real estate activity over the next two years, and drive the headline and core CPI inflation below the 2% target in the second half of 2024. As such, we suspect the Bank should “pivot” to interest rate cuts in the first half 2024 and begin the process of lowering rates towards neutral.

Capital Economics said financial markets were currently pricing rates peaking around 4.5%, while broader market consensus suggested a peak of 2.5%.

Carol N. Valencia