Inflation Outlook and Rate Hikes: Assessing the Impact on UK Economy and Consumers

Inflation data should look a bit better by the autumn

Whether or not the Bank ends up delivering the five extra rate hikes priced into markets heavily depends on whether the inflation numbers show some improvement over the summer. At the headline level they should, though mainly because a 20% cut in household energy bills this month will shave off roughly one percentage point from annual CPI.

In theory, this matters little, but policymakers have put a lot of store in inflation expectations surveys over the past year or so, and the fall in electricity, gas and petrol prices has helped drive these down among consumers and businesses alike. Indeed the plunge in natural gas prices should start to show through in lower services inflation, albeit gradually. By November’s meeting, we think there will be sufficient evidence for the Bank to finally end its hiking cycle. Ultimately most – though not all – of the UK’s inflation drivers are shared with other developed market economies.

Either way, Bank Rate close to 6% is very restrictive by historical standards. Higher loan-to-income multiples mean that mortgage repayments are now equivalent to roughly 35% of average disposable income. That’s a bigger share than when rates peaked ahead of the global financial crisis.

Admittedly most mortgages are fixed for at least two years, which means most households are yet to encounter higher repayments. That means a recession isn’t inevitable, but we will see an ever-increasing drag on the UK consumer. The bigger risk in the short-term arguably comes from corporates (particularly small firms), which are typically on floating interest rates and are feeling the squeeze most acutely right now.