Market News

A drop in inflation will push the Bank of England (BoE) to cut interest rates to 4% this year, according to a study by a leading forecaster.

Despite a surprise increase in price rises to 4% in December, EY Item Club said inflation is still set to drop to the Bank’s 2% target by May.

This will allow Threadneedle street to cut interest rates from their 15-year high of 5.25% to 4% by the end of the year, the advisory business said.

The Bank of England raised rates in a bid to tackle the pace of price rises in the UK, which has strained the finances of UK households.

Martin Beck, chief economic advisor to the EY Item Club, however, warned about risks to the forecast.

“Ongoing geopolitical tensions could push up energy prices, which may slow the decline of inflation and increase costs for households and businesses,” he said.

“Plus, while the Bank of England is expected to reduce interest rates this year, the timing and extent of these cuts remain uncertain and continued high rates could prolong financial strain. The first half of 2024 should tell us a lot about the UK’s prospects of returning to growth over the medium to long term,” he added.

Financial markets and traders are widely expecting the BoE to cut its base rate in 2024 due to the inflation rate falling sharply since peaking at 11.1% in October 2022, which was the highest rate in 40 years.

Ruth Gregory, deputy chief UK economist at Capital Economics, said she expected the first interest rate cut by June.

"As a result, we still think that inflation will be below the 2% target by April and the Bank of England will be in a position to start cutting interest rates by June."

However, Charles Hepworth, investment director at GAM, said sticky inflation could scupper hopes of early interest rate cuts.

“In light of recent economic news from the UK and elsewhere, it now seems that hopes for early cuts in rates from global central banks were a tad optimistic,” he said.

“This all translates into murkier forecasting for the Bank of England as to when they can begin to ease rates, and by implication that directly impacts market sentiment, with gilt yields rising across the curve,” he added.

The Bank of England will announce its decision on interest rates at about midday on 1 February.