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Base rate to peak at a lower 4.5%, experts predict

Paloma Kubiak
Written By:
Paloma Kubiak

Think tank Capital Economics has lowered its forecasted base rate peak from 5% to 4.5% to reflect changes in government policy and an easing of inflationary pressures on the horizon.

The 4.5% rate is expected to be reached by the end of Q1 2023 due to pressures on domestic prices that are expected to keep them high in the short-term.

The ecoomic consultancy said that its previous 5% prediction was based on the former Chancellor Kwasi Kwarteng’s September mini Budget which implied that a loose fiscal policy of cutting taxes and increasing public spending would boost demand and also inflation.

Since the arrival of Jeremy Hunt as Chancellor, however, the organisation said it was clear that fiscal policy was not going to be as loose over the next two years and would become tighter beyond the tax year 2024/25.

In the Autumn Statement, Hunt revealed plans to deliver a £54.9bn package of tax hikes and spending cuts in 2027/28.

The softening of Capital Economics peak base rate forecast has also been influenced by indications that pressures driving up UK prices will ease ‘further ahead’.

In October, price pressures on goods in the US that are central to its inflation measure had begun to soften which Capital Economics said increases the chances that the UK will follow suit. UK job vacancies have also fallen which relieves pressure from the labour market to call for higher wages.

Furthermore, there has been a decline in starting salaries for workers using recruitment agencies which the organisation said was an early indicator of wider earnings growth.

Labour market could create a base rate spike

Paul Dales, chief UK economist for Capital Economics, said: “We think that domestic price pressures will remain strong over the next three to six months and that, as a result, the Bank will raise interest rates from 3% now to 4.5%. We have pencilled in 50 basis point increases at each of the policy meetings in December, February and March.”

The organisation said the base rate could rise to 5% if the labour market was more resilient than expected and if domestic price and wage pressures took longer to ease. But this prediction was at the top of its range for the base rate.

Capital Economics’ central forecast of 4.5% is now more in line with the market consensus that the base rate will peak at 4.25%.

The Bank of England’s chief economist Huw Pill echoed the view of Andrew Bailey, governor of the Bank, that the bank rate need not rise to the levels previously anticipated by the financial markets.

In his speech to the Institute of Directors in London, he said: “I do not anticipate the levels of bank rate priced in financial markets when the forecast’s conditioning assumptions were frozen will be required.

“But, given the need to contain the risk of greater inflation persistence implied by potential second round effects, further action is likely to be required to ensure inflation will return sustainably to its two per cent target over the medium term.”