In its World Economic Outlook, the International Monetary Fund (IMF) said headline inflation would continue to rise this year, “partly because of changes in regulated prices”.
This was up from a prediction of 3.2% made in April.
The IMF said this would be temporary, with a loosening labour market and moderating wage growth bringing inflation back to target by the end of next year.
The organisation forecast that inflation in the UK would fall to 2.5% by 2026.
The IMF said central banks were facing “increased pressure”, but the trust in them and their ability to stabilise prices to manage inflation was “well-anchored”, even in times of large economic shocks, such as the recent cost-of-living crisis.
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Limited scope to cut the base rate
Russ Mould, investment director at AJ Bell, said the UK had an inflation problem that could “constrain the Bank of England’s ability to steadily cut interest rates”.
He added: “That could weigh on consumers and businesses, potentially leading to more sluggish economic growth.
“Even though the rate of inflation might slow next year, the IMF’s prediction still puts the figure further away from the Bank of England’s 2% target.”
Mould added: “Central banks raise rates when they’re trying to combat high inflation, and they cut them when inflation looks like it is under control. An inflation figure starting with ‘3’ is arguably outside of the Bank of England’s comfort zone, so it might be forced to keep interest rates steady. Normally, that wouldn’t be such a problem – if it wasn’t for a fragile jobs market.”
Data released today found that the unemployment rate had risen from 4.7% to a four-year high of 4.8% over the three months to July.
Mould said: “Central banks look at both inflation and labour when making interest rate decisions, and a weak jobs market might traditionally call for rate cuts. It suggests the Bank of England is stuck between a rock and a hard place.”
The IMF also predicted that GDP in the UK would rise to 1.3% both this year and next year, up from its original forecast in April.
It said this reflected strong activity over the first half of the year, and an improvement in the external environment including the UK-US trade deal announced in May. However, the growth is still 0.4 percentage points lower than the IMF’s forecast in October last year.
The Chancellor must announce pro-growth policies
Lindsay James, investment strategist at Quilter, said the report was not welcome reading for the Treasury ahead of the “crucial Budget”.
James said: “Whilst persistent higher inflation risks changing consumer spending patterns and creating a wage-price spiral, the most recent employment report out today showed that wage inflation has barely changed in recent months. The inherent shortage of workers in many areas of the economy, combined with demographic challenges, seems likely to keep wage inflation relatively persistent.
“Furthermore, as we move through 2026, then pressures that are expected to be ‘one-offs’, such as higher National Insurance for employers and the step change in the minimum wage, will wash out of the figures. Whether the next Budget introduces more ‘one-off’ hikes, however, remains to be seen.”
She added: “This should be a shot across the bows for Rachel Reeves. The next Budget must not push yet more costs onto businesses at a time when inflation risks becoming more embedded; it ultimately ends up being shouldered largely by consumers, the very ‘working people’ she has said she wants to protect.
“She will need to come to the despatch box with genuinely pro-growth policies or face the reality that spending will need to be reined in to ease the nation’s debt burden. It is an unenviable position, given neither are particularly easy to achieve.”
