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A fun game financial commentators like to play is to back-engineer logic from prices. Take, for instance, Britain.
Markets have been pricing in two-and-a-bit Bank of England interest rate cuts this year, the first coming next month, and a terminal rate of about 4 per cent. It must track therefore that sticky above-target inflation is eclipsing all concerns about stagflation and debt sustainability — even though it looks increasingly like the opposite must be true.
So true, in fact, that even Goldman Sachs feels a need to say the market’s got this one wrong:
Goldman economist Sven Jari Stehn and team point to the UK’s December retail sales miss and a likely fourth-quarter deterioration in GDP growth, which they expect to be negative.
Any improvement to come from higher government spending and a decline in the savings rate will be offset by the recent rise in long-term rates, a weakening of household real disposable income growth, trade tensions, and the fading benefit of front-loaded Autumn Budget measures, GS tells clients in a note published overnight.
Meanwhile, job surveys and alternative data such as HMRC’s PAYE payrolls suggest a tougher labour market than presented in the official unemployment statistics, it says.
The broker also argues that — but for private rents, school fees and water bills — services inflation would be cooling:
In particular, the introduction of VAT on private school fees in January will push up on education prices, while vehicle excise duty and sewerage prices are set to increase notably in April. Also, we think that the pass-through from the increase in employer National Insurance to prices will likely be larger than the OBR expects. But we see clearer progress in measures of underlying services inflation and — given fading price catch-up effects and softening demand — look for inflation to return towards target in 2026:
Goldman’s forecast is for just 0.9 per cent UK GDP growth this year, which is a lot lower than consensus (1.3 per cent), the BoE (1.5 per cent) and the OBR (2 per cent). This is no time to keep policy restrictive, the team says:
While the range for the real neutral policy rate (or r*) is large, the estimates we consider centre around 0.75%, implying a nominal neutral rate of around 2.75% with inflation at target. The uncertainty around these estimates is very large, consistent with BoE reluctance to place too much weight on neutral rate estimates in practical policymaking. But we are skeptical that Bank Rate can stay above 4% persistently—as priced by financial markets—without materially weakening the economy and thus inflation.
We should therefore be looking at a Bank rate of 3.25 per cent by the second quarter 2026, with the 10-year gilt yields likely to fall to 4 per cent by year-end, Goldman says:
While it is possible that the BoE will slow the pace of cuts if underlying inflation fails to make progress (20% probability), we believe that a step-up to a sequential pace of cuts in response to weaker demand is actually more likely (30% odds).
Over to you, Andrew. An expectant nation waits.
Further reading:
— Only one man can save Britain now (FTAV)
