We get the latest UK inflation figures on Wednesday. The last two sets of numbers showed unexpected increases in core inflation which led to fears that the Bank of England (BoE) would raise rates further and faster. That key influence on mortgage rates – the 5-year swap rates – jumped by over 1% and hundreds of mortgage deals were pulled by lenders. If we get good numbers on Wednesday, we could see a partial reverse with mortgage rates falling. I claim no great skill in forecasting the month-to-month figures on UK inflation, but I know someone who has a good track record. Sam Tombs of Pantheon Macroeconomics is the number one forecaster in this area according to Bloomberg who compile the numbers. He is looking for only a modest increase on the month and is one of the few forecasters expecting the annual rate of core inflation to fall. One month does not make a trend, UK inflation will still be far too high even if Sam is right. I fully expect the BoE to press ahead with a 50 bps rise in base rates at their meeting on 3 August. But I think we will see a steady improvement in the prospects for UK inflation and interest rates as the summer turns to autumn.
I have previously discussed the role of sterling’s weakness last year which, given the lags could account for up to 2% of current inflation. That’s a lot and sterling’s recent strength means that the 2% boost is set to disappear and turn into a negative influence over the next year or so. Even if sterling merely maintains its current level. There are other favourable influences such as household energy bills. They will be up by 200% in this week’s figures but will be down by about 17% in July’s released next month and are likely to fall again in October.
But for a sustained fall in inflation, we need to see lower wage inflation – and that has been accelerating which is a worry. But the latest figures have been inflated by April’s 10% rise in the minimum wage. The BoE has highlighted the importance of the 3-month annualised number but that isn’t just double counting, it’s quadruple counting. This may well have exaggerated fears in the market and more importantly, the labour market is easing, albeit from super tight levels. As headline inflation falls, wage pressures should ease, let’s hope that helps resolve the doctors’ dispute
I do not deny the great uncertainty surrounding the outlook for UK interest rates. The 5-year swap rate, and hence mortgage rates, is influenced by base rates today and over the next 5 years so any forecast much be treated with great caution. Even if I’m right they won’t fall to anywhere near the exceptionally low figures seen in the pandemic. But I do think we may have seen the peak.