The United Kingdom is the only advanced country with wage growth above core inflation, risking a wage-price spiral. Inflation is broad-based and expected to remain much higher than in the rest of the G7, above 6.0% in 2023 and well above 3.0% by end-2024. Growth will be flat at best, but all risks point to the downside.
Core inflation will be difficult to tame in the short term amid persistent wage pressures on account of a very tight labour market due to the impact of Covid-19 and Brexit, while high mortgage rates add to the cost of living.
More monetary tightening is inevitable. Markets expect rates to peak well above 6.0%, but the BoE will have to choose between tightening too much – pushing mortgage rates higher and triggering a recession – and patience in attaining its inflation target. We expect a peak rate of around 5.5%.
A high share of variable-rate mortgages will reduce activity in the housing market and sustain pressure on rents, but house prices are unlikely to correct precipitously because of insufficient supply and the fact that around half of homeowners have no mortgage debt. Higher rates will also increase income on savings, thus moderating the overall effect of monetary tightening on activity.
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