UK Inflation: Don’t get too optimistic | Insight Investment

With inflation decelerating, markets have rushed to price in rate cuts by the Bank of England. Although we see some potential for the bank to edge rates downwards, we believe markets are missing the bigger picture. The UK has lost considerable credibility in recent years, and much work will be needed to restore it – part of that process will be a need to keep policy tighter than other major economies to ensure inflation does not become embedded.

A key problem facing the Bank is the scale of the UK inflation overshoot relative to the US or eurozone. Even if the year-on-year rate of inflation moderates from here to a level closer to target the gap will remain over time, with inflation trending from this higher baseline. It’s hard to see how the Bank can simply ignore this overshoot as for years to come consumers will be trying to regain lost purchasing power, with wage demands likely to remain elevated as a result.

Figure 1: The gap between the level of prices and the Banks inflation target is huge

Source: Insight and Bloomberg. Data as at 31 October 2023.