Key Takeaways
- The National Institute of Economic and Social Research (NIESR) increased its UK GDP growth forecast for 2024 to 0.8%, up from its previous projection of 0.7%.
- UK 10-year Gilt yields rose by 2 basis points to 4.18% immediately following the NIESR's updated economic outlook.
- NIESR projects inflation will remain above the Bank of England's 2% target until at least Q4 2025, delaying anticipated interest rate cuts.
- The institute also revised its 2025 growth forecast upwards to 1.2%, from 1.0%, reflecting improved underlying economic resilience.
NIESR Adjusts UK Economic Outlook Amid Inflation Concerns
The National Institute of Economic and Social Research (NIESR) has elevated its UK GDP growth forecast for 2024 to 0.8% from 0.7%, citing stronger-than-expected economic activity in the first quarter of the year. This upward revision reflects a more resilient economic performance than previously anticipated, driven by easing energy prices and recovering consumer confidence.
However, this positive adjustment was immediately tempered by the institute's stark warning that inflation is expected to remain above the Bank of England's 2% target until at least the fourth quarter of 2025. This extended period of elevated inflation suggests that the Monetary Policy Committee (MPC) will face prolonged challenges in easing monetary policy, potentially delaying interest rate reductions. The NIESR also revised its 2025 growth forecast to 1.2%, up from 1.0%, indicating a gradual strengthening of the economy over the medium term.
Market Impact
UK 10-year Gilt yields rose by 2 basis points to 4.18% in immediate trading following the NIESR report, signaling a cautious market repricing of interest rate expectations. The $GBP/USD pair saw a marginal uptick of 0.05% to 1.2545, reflecting a nuanced reaction to the conflicting signals of improved growth prospects and persistent inflationary pressures. The FTSE 100 index remained relatively stable, experiencing a slight dip of 0.1% to 7,920 points, as investors digested the implications for corporate earnings and borrowing costs.
The modest rise in Gilt yields marks the highest level since early April, indicating that bond markets are beginning to factor in a "higher for longer" interest rate scenario, consistent with the NIESR's inflation outlook. This contrasts with earlier market expectations for more aggressive rate cuts in 2024. Cross-asset spillover effects include potential pressure on domestically focused UK equities, particularly those sensitive to consumer spending, as real wage growth may continue to be eroded by inflation. Conversely, UK financial stocks, such as $LLOY and $BARC, have shown resilience, as a prolonged period of higher interest rates could support their net interest margins.
What Analysts Are Saying
"According to Jane Harding, Chief UK Economist at Barclays, the NIESR's revised forecast aligns with a broader consensus shift towards a more resilient UK economy, but the inflation persistence remains the critical policy challenge for the Bank of England." She emphasized that the market is now pricing in fewer than two 25-basis-point rate cuts for 2024, a notable reduction from the three cuts anticipated at the beginning of the year, reflecting a recalibration of expectations.
Goldman Sachs analysts noted that while the headline growth figures are encouraging, the underlying inflationary pressures, particularly from services and wage growth, suggest that the Monetary Policy Committee (MPC) will likely maintain its hawkish stance longer than previously anticipated. They project a first rate cut no earlier than August 2024, contingent on a sustained deceleration in core inflation below 3.5% and a moderation in wage growth.
A somewhat contrarian view emerged from Capital Economics, suggesting that the NIESR might be underestimating the speed at which disinflationary forces could bring CPI back to target earlier than Q4 2025. Their analysis points to the lagged effects of falling wholesale energy prices and easing supply chain pressures, alongside a cooling labor market, potentially allowing for earlier rate cuts in Q3 2024, provided that core CPI shows consistent deceleration below 3%.
What to Watch
The timing and magnitude of any future interest rate adjustments from the Bank of England remain the paramount concern for investors. The next critical date is the MPC meeting on May 9, where updated economic projections and any shifts in forward guidance will be closely scrutinized. Investors will be looking for clues regarding the timing and magnitude of potential rate cuts, with market consensus currently leaning towards an August or September initiation of a 25-basis-point reduction from the current 5.25%.
Upcoming Consumer Price Index (CPI) releases, particularly the April data due mid-May, will be paramount in shaping market expectations. A significant drop in headline and core CPI below 3.5% could provide the MPC with more room to consider easing policy. Conversely, persistent readings above 4% would reinforce the NIESR's concerns about embedded inflation and likely push back the timeline for rate cuts.
The UK labor market remains a key driver of services inflation, making average weekly earnings data, especially ex-bonuses, a critical metric to monitor. Investors will be watching for signs of deceleration from its current annual rate of approximately 6%. Any sustained easing below 5% in wage growth would alleviate some of the inflationary pressure, potentially giving the Bank of England greater flexibility.
With a general election looming, any pre-election fiscal measures or commitments could significantly impact the inflation outlook and the Bank of England's policy decisions. Substantial fiscal stimulus could exacerbate inflationary pressures, potentially requiring the MPC to maintain higher interest rates for longer, while any unexpected austerity measures might have the opposite effect, creating a complex interplay between fiscal and monetary policy.