As the new year gets underway, all eyes are on the UK economy and the persistent inflation that has been a thorn in the side of the Bank of England. The latest forecasts suggest that UK inflation will remain steady at 2.6% for December 2022, still sitting uncomfortably above the central bank’s targeted 2% level.
While the word “steady” usually has positive connotations, in this case, it spells ongoing challenges for policymakers and concerns for investors. The elevated inflation rate continues to put pressure on the Bank of England to take action, even as economic growth shows signs of slowing.
Core Inflation Remains Stubbornly High
One small glimmer of hope in the inflation data is that core inflation, which strips out volatile components like food and energy prices, is expected to decline slightly to 3.4% in December. However, this is still significantly higher than the Bank of England’s comfort zone.
While it’s too early to be talking about the prospect of stagflation, it’s certainly something already concerning many investors.
– Michael Field, European equity strategist at Morningstar
The combination of stubbornly high inflation and slowing economic growth has raised the specter of stagflation – a challenging scenario where inflation remains elevated even as the economy stagnates. This puts central banks in a difficult position, as they try to balance the need to control inflation with the desire to support economic activity.
Implications for Interest Rates
The persistently high inflation readings are likely to impact the Bank of England’s approach to interest rates in the coming months. Some investors have been critical of the seemingly slow pace of rate cuts, arguing that more needs to be done to stimulate the economy.
Ultimately, we do not believe that inflation will ramp up any further, but getting inflation consistently closer to the key 2% level might be difficult from here. So perhaps we should already be adjusting our expectations for interest rate cuts in 2025.
– Michael Field, Morningstar
If inflation proves stubborn and fails to trend back towards the 2% target, the Bank of England may be forced to moderate the pace of interest rate cuts or even pause them altogether. This could disappoint markets that have been pricing in a steady stream of rate reductions.
Global Inflation Picture
The UK is not alone in grappling with above-target inflation. The US inflation figures for December are also due out later today and are forecast to tick up to 2.9% from 2.7% in November. This highlights the global nature of the inflationary pressures that have emerged in the post-pandemic world.
Central banks around the world are walking a tightrope as they try to bring inflation under control without tipping their economies into recession. The US Federal Reserve has already scaled back its projections for rate cuts, with markets now pricing in just one quarter-point reduction by the end of 2025.
Market Reaction and Outlook
The UK inflation data will be closely watched by market participants as they assess the likely path of monetary policy in the months ahead. A higher-than-expected inflation reading could weigh on sentiment and push bond yields higher as investors price in a more hawkish central bank.
Currency markets will also be in focus, with the value of the British Pound likely to be influenced by the inflation figures and their implications for interest rates. A strong inflation print could lend support to the Pound, while a weaker number may see it lose ground against its major trading partners.
Looking ahead, the key question for investors is whether UK inflation has peaked or if there are further upside surprises in store. Much will depend on the trajectory of energy prices, the post-pandemic recovery in demand, and the extent to which supply chain disruptions persist.
- Base effects may start to work in favor of lower annual inflation readings as we move through 2023, but this will be dependent on fresh price pressures remaining contained.
- The tight labor market and rising wage demands also present upside risks to the inflation outlook, as businesses may look to pass on higher costs to consumers.
For now, all eyes will be on the December UK inflation data and the subsequent market reaction. While a single data point is unlikely to significantly alter the economic landscape, it will provide important clues as to the challenges that lie ahead for policymakers and investors alike.
| Key Takeaways |
|---|
| UK inflation expected at 2.6% in December |
| Bank of England target of 2% remains elusive |
| Core inflation to edge down but still elevated |
| Interest rate outlook hinges on inflation path |
| Global inflation pressures persist |
As always, investors will need to stay attuned to the latest developments and be prepared to adjust their portfolios as the economic picture evolves. While uncertainty abounds, those who are able to navigate the shifting currents and maintain a long-term perspective may be well-positioned to weather whatever storms lie ahead.
