The British public’s inflation expectations for the coming year have fallen to their lowest level in three years, according to a Bank of England (BoE) survey released in September 2024. This dip in expectations is likely to reassure policymakers as they prepare for the central bank’s upcoming interest rate decision, which is scheduled for later this month.

The BoE closely monitors surveys of public inflation expectations as a key indicator of future inflation trends. These expectations often influence consumer behavior, wage negotiations, and business pricing strategies. As such, understanding how the public perceives inflation can provide valuable insights into how actual inflation may evolve over time.

The recent survey indicated that inflation expectations for the next 12 months dropped to 2.7% in August, down from 2.8% in May 2024. This represents the lowest level since August 2021, a significant drop that reflects growing optimism among consumers that inflationary pressures may be easing. Despite concerns about global economic volatility, this development aligns with the BoE’s broader efforts to bring inflation back to manageable levels after several turbulent years.

Background on Inflation Trends and BoE Policy

In recent years, inflation in the UK has been a persistent concern, driven by a combination of factors, including the global pandemic, supply chain disruptions, and geopolitical tensions, particularly Russia’s invasion of Ukraine in 2022, which sent energy prices soaring across Europe. At the height of the crisis, inflation spiked dramatically, peaking at 11.1% in October 2022, the highest in four decades.

To combat rising inflation, the BoE implemented a series of aggressive interest rate hikes, culminating in a 16-year high of 5.25% in August 2024. These hikes were aimed at slowing down the overheated economy and cooling consumer demand, thereby preventing runaway inflation. The BoE’s Monetary Policy Committee (MPC) expressed optimism during the rate cuts earlier in August, noting that the recent reductions in inflation expectations were expected to lead to lower wage demands and smaller price increases by businesses.

Inflationary pressures have indeed eased over the past several months, with consumer price inflation (CPI) returning to the BoE’s target of 2% in both May and June of 2024. However, inflation edged slightly higher in July, reaching 2.2%, and the BoE’s forecast suggests that inflation could rise to around 2.75% by the end of the year before declining again.

What the Latest Survey Reveals

The BoE’s quarterly inflation attitudes survey, which was conducted between August 2 and August 6 and involved over 2,000 participants aged 16 to 75, revealed that the public’s inflation expectations for the next 12 months fell to 2.7% in August from 2.8% in May. The survey also found that expectations for inflation over the following 12 months remained unchanged at 2.6%. However, expectations for inflation five years ahead increased slightly to 3.2%, up from 3.1%, marking the highest level in nine months.

The slight uptick in longer-term expectations suggests that while the public is more confident in the BoE’s ability to manage inflation in the short term, some uncertainties remain about inflationary pressures further down the road. The UK economy continues to grapple with several potential risks, including volatile energy prices, supply chain constraints, and the broader global economic environment.

Public satisfaction with the BoE’s control of inflation has also improved, according to the survey. The net balance of satisfaction with the BoE’s inflation management rose to +4 in August, compared to -4 in May. This is the highest satisfaction rating since February 2022, indicating that public confidence in the central bank’s inflation-fighting efforts has rebounded significantly in recent months.

Interest Rate Outlook

Economists polled by Reuters in early September 2024 predicted that the BoE is likely to leave interest rates unchanged at 5% at its next meeting on September 19. However, they anticipate a rate cut to 4.75% at the BoE’s subsequent meeting on November 7, 2024, as inflationary pressures are expected to continue easing. The forecasted cut would mark the first reduction in interest rates since the central bank began its aggressive rate-hiking cycle in response to inflation in 2021.

The BoE’s cautious approach reflects a delicate balancing act between containing inflation and preventing an economic slowdown. High interest rates have made borrowing more expensive for businesses and consumers, which has led to concerns about a potential recession. At the same time, inflation remains a concern, particularly as the labor market continues to exhibit signs of tightness, with wage growth remaining strong.

The BoE’s focus on inflation expectations is part of its broader strategy to ensure that inflation does not become entrenched in the economy. Persistent high inflation can lead to a self-fulfilling cycle, where businesses raise prices in anticipation of higher costs, and workers demand higher wages to keep pace with rising prices, creating further upward pressure on inflation.

Global Context

The UK’s inflation battle is part of a broader global trend, with many central banks around the world grappling with similar challenges. The European Central Bank (ECB), for instance, has also implemented a series of rate hikes in response to inflationary pressures across the Eurozone. In the United States, the Federal Reserve has adopted a similar approach, raising interest rates to combat inflation, although the pace of rate hikes has slowed in recent months as inflation has shown signs of moderating.

Energy prices, particularly oil and gas, continue to be a key driver of inflation globally. The recent rise in oil prices, driven by production cuts from major oil-producing countries, has the potential to reignite inflationary pressures. This underscores the importance of global supply chains and energy markets in shaping the inflation outlook for the UK and other economies.

Implications for Businesses and Consumers

The easing of inflation expectations is good news for businesses and consumers in the UK, as it suggests that the worst of the inflationary surge may be behind them. Lower inflation expectations could lead to more stable prices for goods and services, which would benefit households by preserving their purchasing power. For businesses, lower inflation expectations could reduce the pressure to raise prices, which, in turn, could help to sustain consumer demand.

However, the rise in longer-term inflation expectations to 3.2% suggests that businesses may still face some uncertainty over costs in the years ahead. Wage growth, which has remained robust in the UK despite the economic slowdown, could continue to be a source of inflationary pressure, particularly if the labor market remains tight. This could pose challenges for businesses that are already struggling with higher input costs and supply chain disruptions.

Conclusion

The Bank of England’s latest survey on inflation expectations offers a glimmer of hope for both policymakers and the public, as expectations for inflation over the next year have fallen to a three-year low. This development is likely to reassure the BoE’s Monetary Policy Committee as it prepares for its upcoming interest rate decision. However, uncertainties remain, particularly with regard to inflation in the longer term and the broader global economic environment.

As the BoE navigates these challenges, it will need to strike a careful balance between controlling inflation and supporting economic growth. For now, the easing of inflation expectations provides some relief, but the central bank’s task is far from over. The next few months will be critical in determining whether the UK economy can achieve a soft landing after years of inflationary turmoil.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

16th September, 2024