The Bank of England finds itself caught between a rock and a hard place as it prepares for a critical interest rate decision on February 6th. Policymakers are grappling with the reemergence of inflationary pressures even as the job market shows signs of strain, complicating the central bank’s efforts to steer the economy towards stability.
According to the closely-watched flash purchasing managers’ index (PMI) for January, the prices charged by UK private sector firms are increasing at the quickest clip in a year and a half. This troubling development suggests that the inflation genie, once thought to be back in its bottle, may be rearing its head once more.
Job Losses Accelerate Amid Economic Uncertainty
Compounding the Bank of England’s woes, the same survey revealed that employers are shedding workers at an alarming rate. In fact, the pace of job cuts is the most severe since the depths of the Covid-19 crisis in 2021, excluding the pandemic period, layoffs are happening faster than at any point since the 2009 global financial meltdown.
This worrying trend can be attributed, at least in part, to the aftermath of Chancellor Rachel Reeves’s autumn budget. The £25 billion hike in employer national insurance contributions, coupled with a substantial 6.7% increase in the minimum wage, has left many businesses with little choice but to trim their workforces or hike prices to stay afloat.
While the stalled economy and deteriorating jobs market suggest there’s an increased need for rate cuts to stimulate growth, the rise in price pressures hints that the inflation genie is by no means back in its bottle.
Chris Williamson, Chief Business Economist at S&P Global
Stagflation Fears Loom Large
The specter of stagflation – a toxic mix of sluggish economic growth and persistent inflation – now haunts the UK. This puts the Bank of England in an unenviable position as it deliberates its next move. On one hand, the stagnating economy and weakening labor market argue for interest rate cuts to jumpstart growth. On the other, the resurgence of inflationary pressures suggests that the central bank’s work in taming rising prices is far from done.
Financial markets are currently pricing in an 81% probability that the Bank will lower rates from 4.75% to 4.5% at its upcoming meeting. However, analysts caution that the monetary authority’s room to maneuver may be constrained by the uptick in inflation. While investors anticipate two quarter-point rate reductions over the course of 2025, the Bank’s ability to deliver sustained accommodative policy could be curtailed if price pressures continue to build.
Inflation Poised to Climb Further
Several factors are conspiring to push inflation higher in the coming months:
- Energy price cap increases: The scheduled January hike in the Ofgem energy price cap, with another expected in April, will add upward pressure on the headline inflation rate.
- Rising goods and food costs: Both goods price inflation and wholesale food prices have ticked up recently, threatening to feed through to consumer prices.
[We continue] to see inflation remaining stubbornly around 3.5-4%, which means that we struggle to see [Andrew] Bailey being able to lower rates much further than this.
Mark Dowding, Chief Investment Office at RBC BlueBay Asset Management
Economic Warning Signs Flash Red
Beyond the inflation conundrum, other economic indicators are flashing warning signs. Insolvency specialist Begbies Traynor reported a staggering 50% surge in the number of UK companies on the precipice of collapse in Q4 2024 compared to the previous quarter. Consumer-facing sectors like retail, hospitality, and leisure are bearing the brunt of the pain.
Meanwhile, data from the CBI lobby group showed that year-over-year retail sales volumes continued to contract in January. At the same time, the widely-followed GfK consumer confidence index sank to its lowest level since 2023.
With recent growth figures showing the urgent need to inject momentum into the economy, the government should look at policy levers that would help shore up confidence across key sectors, including retail.
Martin Sartorius, Principal Economist at the CBI
Pressure Mounts on Policymakers
As the Bank of England’s interest rate decision looms, pressure is building on policymakers to find the right balance between supporting growth and keeping inflation in check. With the economy teetering on the brink and the jobs market showing cracks, the case for accommodative monetary policy is growing stronger by the day.
Yet the central bank cannot afford to take its eye off the inflation ball. If price pressures continue to percolate and become entrenched, the Bank of England may find itself forced to slam on the brakes again, potentially tipping the economy into a painful recession.
As the saying goes, central bankers are faced with an unpalatable choice: “take away the punch bowl just as the party gets going.” In this case, Governor Andrew Bailey and his colleagues must decide whether to keep the easy money flowing or start sobering up the economy before inflation spirals out of control.
The stakes could hardly be higher. With the UK at an economic crossroads, the Bank of England’s upcoming interest rate decision will have far-reaching implications for businesses, consumers, and the government. Will policymakers thread the needle and engineer a soft landing? Or will the economy be left nursing a painful hangover? Only time will tell.
