The government’s decision to freeze the price of domestic natural gas and electricity will reduce headline inflation in coming months, but will stimulate the economy just as the Bank of England tries to prevent a spiral in domestic prices.
Nomura estimated that the central bank will raise its key rate to 3.75% in the coming months, from its previous forecast of 2.5%. NatWest Markets added half a point to its outlook, which now stands at 3.5%.
The UK central bank made its biggest rate hike in 27 years last month, raising the benchmark to 1.75%. Investors are betting on another half point, with a 40% chance of a 75 basis point move next week.
JPMorgan Securities is even more bullish. Economist Allan Monks anticipates a further 50 basis points of central bank hikes and just one negative quarter of growth for the UK economy. Monks expects a 75 basis point hike next week.
“A 50 basis point hike at next week’s meeting would be a soft-spoken surprise,” Monks wrote in a note. “This would be difficult to justify on the heels of a large, unfunded and misguided fiscal easing that has been accompanied by a decline in market confidence in the sustainability of the UK’s fiscal position.”
The Treasury anticipates that the support, which is forecast to cost more than £100bn, will reduce peak inflation by 4-5 percentage points from the 15% high currently forecast by economists.
The concern is that shielding households from a rise in energy prices will fuel domestically generated inflation by spreading beyond utility bills into the cost of goods and wages.
“By shielding household finances from higher energy prices, the government is significantly increasing the amount of demand in the economy, which will boost underlying inflationary pressure,” said Luke Bartholomew, senior economist at fund manager Abrdn. , who also forecasts a 75 basis point hike next week. “This means the bank will need to raise interest rates even more quickly.”
Goldman Sachs forecasts half-point rate hikes at each of the next three meetings, which would take the benchmark interest rate to 3.25% by the end of the year. It has raised its maximum forecast to 3.5%.
Fabrice Montagne, an economist at Barclay’s, said the rescue package would allow the Bank of England to “refocus on the domestic drivers of inflation.”
“In our view, falling inflation will remove support for a prolonged cycle of hikes,” he said. Barclays anticipates rates will top 2.5% in November.