Healthy economic recovery this year and next as interest rate cuts support activity
UK headline CPI inflation and Bank rate (%)
Policy rate to be cut to 3.00% by end-2025
The surge in energy prices over 2022 has largely reversed and global inflation has fallen sharply. Headline CPI in the UK has eased from its 41-year high of 11.1% in October 2022 to 2.2% in July 2024. However, sticky services inflation had been preventing the Bank of England from cutting interest rates until August this year. Signs of a looser labour market and the economy growing below potential enabled the Bank to cut rates in August for the first time since March 2020, from 5.25% to 5.00%. We expect inflation to fall below the 2.0%-target by mid-2025. The UK economy has hardly grown since the pandemic. At the end of 2023, real GDP was just 1.0% higher than its level in 2019. There is therefore spare capacity in the economy. That, paired with a rise in labour supply should help bring services inflation down further. We expect the Bank to cut the policy rate to 4.50% by the end of this year, and to 3.00% by the end of 2025.
CPI inflation
Bank rate
2% target
10 12
CE forecast
0 2 4 6 8
2016
2018
2020
2022
2024
2026
UK real GDP quarter-on-quarter and year-on-year change (%)
Real GDP growth to average a healthy 1.5% in 2025 and 2026
% q/q (LHS)
% y/y (RHS)
1.5
15
The high interest rate environment and cost of living crisis seen over the past few years has weighed on consumer spending and housing activity. The economy experienced a very mild recession at the end of last year, involving a 0.5% fall in real GDP. The economic recovery is already underway, as real GDP rose by 0.7% on the quarter in Q1 2024 and by a further 0.6% in Q2. Lower inflation and falling interest rates are set to support disposable incomes and consumer spending, along with investment over the next few years. We expect real GDP to grow by 1.2% in 2024, and by a stronger 1.5% in 2025 and 2026.
CE forecast
1.0
10
0.5
5
0.0
0
-0.5
-5
2022
2023
2024
2025
2026
Sources: Capital Economics and Refinitiv
9
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