Inflation eased back to 6.8 per cent in the year to July down from the eye-watering, 40-year high of 11.1 per cent in October last year.
While the government has pledged to halve inflation by the end of the year, and the latest forecast from the Bank of England’s Monetary Policy Committee (MPC) suggested five per cent by December 2023, Deutsche Bank economists are more optimistic.
They said they see the Consumer Prices Index (CPI) measure of inflation slowing to 4.6 per cent in three months’ time – that’s 40 basis points below the official forecast.
Sanjay Raja, senior economist at Deutsche Bank, wrote: “While August CPI will almost certainly bump up (due to higher pump prices and alcohol duty), it will remain firmly on a downtrend. Another drop in energy prices will bring CPI lower in October (dual fuel bills will fall by seven per cent).
“Food prices are starting to normalise, with plenty of downward momentum in the pipeline. Core goods inflation is now matching modelled forecasts, given falling import price pressures and PPI pressures. And we expect to see some downward momentum in things like catering prices, as firms’ food and energy bills look less worrying than a year ago.”
Base rate peak near
Raja added this is important as easing inflationary pressures will give markets “more optionality to price in more rate cuts over 2024 by the end of this year”.
Indeed, the Bank of England’s MPC has raised the base rate 14 times in a row (now at 5.25 per cent) since December 2021 in a bid to curb inflation. But the bulk of monetary policy tightening is yet to fully feed through into the economy. Given this, Deutsche Bank said the BoE is unlikely to go much further.
“Our base case includes two more hikes – in September and November – but there are increasing doubts surrounding our call.
“Recent BoE speak suggests the bar for further hikes may be rising faster than we thought. The MPC seemingly has more confidence in its models. It may also be taking a cue from other central banks who are actively countenancing a pause,” Raja wrote.
He added that recession risks “are also likely to play a role in the Bank’s unease in hiking much further”.
Recession risks
The economist explained that so far, the UK has avoided technical recession “despite warning signs burning bright for much of the year”.
But latest business surveys “have reignited recession fears”, Deutsche Bank said, and it therefore can’t rule out recession just yet.
However, it doesn’t see the economy contracting in Q3 2023 due to “strong carry-over effects from Q2” and a pick-up in real disposable incomes which mean the economy will continue to grow modestly (0.2 per cent quarter-on-quarter).
Raja added that unemployment is also picking up (0.4 percentage points to 4.2 per cent this year) as redundancies rise and vacancies fall and suggested the jobless rate could reach 4.5 per cent by December, “well above the MPC’s estimate of 4.25 per cent”.
He said: “While we continue to see the UK economy avoiding a downturn over the next year or so, we also recognise that it won’t take much to tip the economy into recession territory.”
