U.K. Economists Upgrade Outlook With BOE Seen Cutting Rates In May

(Bloomberg) -- Britain’s economic prospects brightened with a pickup in lending and two prominent forecasters anticipating stronger growth and rate cuts early this year.

Goldman Sachs and Bloomberg Economics both upgraded their outlook for growth and predicted the Bank of England will reduce borrowing costs starting in May. The central bank released figures showing a jump in mortgage approvals and consumer borrowing and a slower decline in money supply.

The moves reflect a quickly improving outlook for inflation, which after hitting the highest level since the early 1980s is now receding toward the 2% target. The BOE said corporate decision makers rapidly scaled back expectations for price increases in the next year to 4% in December, the lowest in a series dating to May 2022.

It sets up the UK for “modest, if unspectacular, growth” in the second half of the year, Dan Hanson and Ana Andrade at Bloomberg Economics wrote in a report published Thursday. Falling inflation gives the BOE “ample space to start easing.”

An economic rebound could help Prime Minister Rishi Sunak’s Conservative Party, which is around 20 points behind the Labour opposition in opinion polls ahead of a general election expected this year. Market expectations that rates will be cut have already handed Chancellor of the Exchequer Jeremy Hunt roughly £10 billion ($12.6 billion) of headroom for the tax cuts he wants to deliver in the March budget.

Goldman now expects 0.6% growth in UK gross domestic product this year, up from 0.5% previously. It raised its forecast for 2025 to 1.3% from 1%.

“Expectations for Bank Rate have fallen substantially over the past three months on the back of softer sequential wage growth and inflation data,” Goldman economist James Moberly wrote in a note. “We expect that the BOE will begin to lower rates in May 2024 and then cut at a 25 basis points per meeting pace.”

The BOE said the number of mortgages given the green light by British lenders rose more than expected in November, as cooling borrowing costs brought buyers back into the housing market.

“The pressure on the UK housing market is easing as mortgage approvals continued to recover in November on the availability of slightly cheaper loan deals,” said Niraj Shah of Bloomberg Economics. “Still, the housing outlook is fragile as borrowing costs are restrictive and demand for mortgages remains well below the 10-year average.”

• Banks and building societies approved 50,067 home loans, up from 47,888 the previous month and the highest since June. Economists had expected an increase to 48,800.
• Unsecured credit jumped by £2 billion ($2.5 billion), the highest figure in almost seven years in a sign of strengthening consumer confidence as wages grow faster than inflation. Economists had expected a figure of just £1.4 billion.
• An underlying measure of money supply contracted 2.3% in November compared with a year earlier, less than the 3.1% drop recorded the month before.
• A separate BOE survey showed executives became more optimistic about inflation last month. Expectations of inflation in three years eased from 3.2% to 2.9%, a record low but above the 2% BOE target. There was also a modest easing in the pace at which firms expect to raise their own prices in the coming year.

However, the Decision Maker Panel data found expected wage growth remained stubbornly high, which may fuel concerns at the BOE about underlying price pressures. Chief financial officers anticipate wages to rise 5.4% over the next year, the highest reading in eight months.

What Bloomberg Economics Says...

“Signs of sticky wage growth in the latest Bank of England’s Decision Maker Panel survey are likely to make the central bank cautious about a dovish pivot early in 2024. Still, evidence that inflation expectations are falling, and with CPI set to drop below 2% as soon as in the spring, we doubt the BOE will be able to hold the line for long. We see the first move down in May with rates ending the year at 4%, from 5.25% currently.”

-Ana Andrade and Dan Hanson, Bloomberg Economics. Click for the REACT

The UK economy is set for a spring boost as inflation falls below the 2% target, the BOE cuts interest rates and the current period of stagnation comes to an end, according to forecasts by Bloomberg Economics.

Hanson and Andrade expect a first quarter-point rate cut from 5.25% in May and for the BOE to take rates down to 4% by the end of the year. The two revised up their forecasts after November inflation fell faster than expected and energy costs stayed lower. They still expect “a very mild technical recession in the near term,” with the economy shrinking 0.1% in each of the third and fourth quarters of 2023 and the first quarter of 2024.

Beyond that, “activity looks likely to pick up steam from the spring, buoyed by a boost to real incomes from lower energy prices, as well as falling interest rates,” they write.

Deutsche Bank senior economist, Sanjay Raja, also struck an upbeat note in a blog entitled “eight reasons for some optimism.” He expects inflation to drop to the 2% target in April or May and thinks it is “possible” rates could be cut to 4% be the year end. “A soft landing remains our base case,” he said.

Simon French, chief economist at Panmure Gordon, and former BOE ratesetter Charles Goodhart have said the UK consumer will come to the rescue this year as incomes rise faster than inflation. The minimum wage, the state pension and working-age welfare benefits will all rise by more than treble the anticipated 2% inflation rate in April.

Raja believes wage growth will also remain elevated and the government will cut taxes again in the budget, giving households a spending windfall. The 2% cut in national insurance contributions from this month announced in November will add £10 billion to incomes this year.

A 1% cut in the basic rate of income tax in April would add another £4 billion this year, and a halving of the inheritance tax rate to 20% would be worth close to £1 billion more for 2024.

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