Interest rate cut delays predicted to subdue growth

The British economy is expected to remain subdued this year due to the Bank of England delaying interest rate cuts in the face of stubborn inflation according to a repott by the EY Item Club.

The report now expects GDP growth of 2% in 2025, up from 1.8% in January’s Winter Forecast. However, the growth forecast for 2024 from EY ITEM Club has been downgraded from 0.9% to 0.7% as the lagged effects of the 2023 technical recession continue to be felt this year.

While it is uncertain whether Consumer Price Index (CPI) inflation will decline to the Bank of England’s 2% benchmark in April due to sticky services inflation, the EY ITEM Club expects it to do so by the second half of 2024, thanks to falling prices of wholesale energy, as well as slowing inflation of food and goods prices. The EY ITEM Club then expects inflation to average just below 2% for the rest of the year.

However, despite an improving inflationary outlook, the EY ITEM Club now expects Bank Rate to end 2024 at 4.50% following 75 basis points (bps) of cuts across the remainder of this year – a less significant reduction compared to the 125bps of cuts predicted in January’s Winter Forecast. Since January’s forecast, the Monetary Policy Committee’s (MPC) messaging has suggested that rates may need to stay high for longer. The EY ITEM Club now anticipates that the first rate cut will come in June 2024, amid expectations of a period of below-target inflation.

Hywel Ball, EY UK Chair, said “Although growth in 2024 is forecast to remain subdued, we still expect this year to mark a turning point for the UK economy and provide a launchpad for a far brighter 2025. High inflation, energy prices and interest rates have mired the UK in economic stagnation in recent years but all three obstacles to growth have now either fallen away already or are expected to diminish in 2024.

“Business investment is predicted to see modest growth this year before accelerating in 2025. Rising business confidence and spending, alongside improved economic conditions, should set the stage for a welcome return to growth in the near future.”

The EY ITEM Club Spring Forecast brings welcome news for homeowners, with house prices predicted to grow by 1.3% this year. Property prices are then forecast to increase by a further 2% in 2025. The recent fall in mortgage rates has put a floor under prices, which have shown more resilience than expected at the start of 2024. The EY ITEM Club therefore expects an improving economy to drive a steady recovery in house prices this year and in 2025.

In line with expectations for GDP, growth predictions for consumer spending in 2024 have been downgraded from 0.9% to 0.7% due to a weaker-than-expected end to 2023. However, 2025 is forecast to see more substantial growth of 2.2% with the anticipated fall in interest rates likely to prompt households to borrow more and save less.

According to the Spring Forecast, the unemployment rate is expected to edge up slightly due to the lagged effect of a weaker-than-expected end to 2023 on business hiring decisions. However, as the economy begins to recover, unemployment should remain low by historic standards.

Peter Arnold, EY UK Chief Economist said “The UK may have slipped into a mild technical recession at the end of 2023, but there are still indications that the UK’s extended period of economic stagnation has already started to draw to a close. Falling inflation and interest rates, alongside tax cuts, should help unlock growth in consumer spending, house prices and real incomes. While 2024 isn’t expected to be a year of enormous economic momentum, it should provide a stepping stone to a far brighter 2025.

“The UK’s performance so far this year suggests that stagnation is lifting, with activity surveys signalling a return to growth across various sectors and improved consumer confidence. The Bank of England’s next set of forecasts in May should show a period of below-target inflation and we believe that Bank Rate cuts could follow as early as June, with a total of up to 75 basis points of cuts this year. As well as alleviating some of the financial pressures on households, this should also create a more positive environment for business investment.”

According to the EY ITEM Club Spring Forecast, prospects for business investment in 2024 are on an upward trajectory. Growth of 0.6% is now expected in 2024, which represents a significant improvement on expectations of a 1% decline in January’s Winter Forecast. However, the fact that interest rates currently remain high is expected to limit the potential scope of growth this year.

Meanwhile, the EY ITEM Club continues to expect 3.2% growth in business investment in 2025. The anticipated cuts to the Bank Rate are expected to reduce existing business debt costs, while encouraging more investment activity going forward.

The most significant risk to the EY ITEM Club Spring Forecast is the potential effect of ongoing geopolitical tensions, which may push up energy prices. In this scenario, inflation may remain elevated, which could in turn have a marked knock-on effect on interest rates, GDP expectations and household spending power. Furthermore, while the EY ITEM Club expects the Bank of England to cut rates in 2024, there is no guarantee on the timing and extent of these reductions. Finally, an impending general election means the future path of government fiscal policy isn’t clear beyond 2025, which presents a significant unknown for longer-term forecasting.