UK Economy update – it’s a ripper!

I should apologise for bleating on about the UK economy so frequently, but I just can’t help myself. What makes the current situation so interesting is that the gloomier the consensus becomes, and the more we are lectured by the Blob about how awful everything is, the better the outlook gets.

I have lost count of the number of times the MPC and OBR, the principal sources of economic gloom, have been wrong about the future trajectory of the UK economy, but right now, I think they are about to excel themselves. Both have growth forecasts for the UK economy that are too low, but less forgivably, their inflation forecasts are, in my view, ridiculously too high. Some might argue that this accusation is unfair, given how far energy prices have moved since both organisations opined on how UK inflation would behave through 2025. But, for the record, I said at the time that their numbers were way too high, and their forecast errors clearly cannot be laid exclusively at the door of energy price volatility.

The catalyst for this latest outburst on my part was this week’s UK inflation data, which was again better than expected at 2.6% in March, rather than the 2.7% forecast. This small improvement may not be that dramatic but is, I believe, a guide to what is likely to happen over the next few months, a period in which the MPC sees inflation leaping to 3.6% in April, and then increasing further to a peak in July of 3.7% (the OBR expects 3.8%).

Inflation is expected to increase in April as water, gas, and electricity bills are increasing this month (the tri-annual energy price cap reset in January, April, and July). However, lower petrol prices will help to offset these increases, and my favourite economist expects the impact of these changes to raise inflation, but only to 3%. The MPC has a forecast of 3.6%.

Importantly, and by way of a guide to what’s happening in the economy right now with prices, in the data published today, not only were fuel prices lower (energy price deflation was 8%) but food price inflation fell, rental inflation continued to ease, and significantly, hotel inflation turned negative. (One other helpful impact on inflation is Sterling’s 10% appreciation against the US dollar so far in 2025)

But the good news doesn’t stop there. After April’s 3% inflation print, I would expect inflation to decline, not increase as both the MPC and OBR expect. Indeed, if oil and gas prices remain close to current levels in July, the energy price cap, in a very welcome development for UK households, will fall by 10% or more, not increase as these two organisations predict. This means that by July, the MPC and OBR could have an inflation forecast that is a full 1% higher than the outturn. Embarrassing to say the least.

Of course, the most important question is how the MPC will interpret this better-than-expected inflation outcome, not just in its May meeting but also in the months ahead.

My guess is that the better inflation data will come as a bit of a shock to the Committee, but their reaction will, to some extent, be dictated by how the 40% of all private sector annual wage settlements in April transpire. The agreements will also come as a welcome surprise to the rate setters as they are, in my view, likely to be struck at a much lower level than the current slowing pace of wage growth, which is 5.9%.

Summary

The MPC and OBR have once again got their numbers badly wrong. Their growth forecasts are too low, but as importantly, their inflation expectations are ludicrously too high.

The MPC will have to reflect this better inflation outcome in a faster pace of rate cuts in 2025 and 2026 than the market currently expects. (There will be three further cuts in 2025 and maybe a further two early in 2026, which would take base rates to 3.25% by Spring next year)

This faster pace of rate cuts will help to catalyse a faster pace of spending growth in the economy and a commensurate reduction in saving, which, according to official data, is now at 12%. (In the US, the equivalent measure is at 3.7%.) I anticipate this will help the economy deliver a better growth outcome.

I am very confident that if I am wrong, it will be because the outturn will be even better than I have suggested here.

Finally, if I am right, the UK stock market should continue to outperform its developed economy peers, led by the performance of its domestic economy, facing constituents.