Services inflation to ‘cool significantly’ paving the way for June interest rate cut
Falling energy prices will help services inflation to “cool significantly” in the months ahead, paving the way for the Bank of England to start cutting interest rates in June, analysts at Goldman Sachs said.
In a note published yesterday evening, economists at the US investment bank modelled how services inflation is likely to develop over the months to come. The measure is a major concern for the Bank of England because it is seen as a better gauge of domestic inflationary pressures than the headline rate.
Services inflation fell to 6.1 per cent in February, down from 6.5 per cent in January but well above the headline rate of 3.4 per cent.
The analysts were confident that there would be further progress in the near future due to the impact of energy prices, which played a big role in the surge in prices in the first place.
“We find that the pass-through effects from higher energy and food prices will unwind rapidly in coming months,” James Moberly and Sven Jari Stehn, economists at Goldman Sachs, said.
“Services inflation will slow markedly over the next 6-9 months as past effects from high energy prices drop out,” they continued.
The economists forecast that services inflation would reach around four per cent by the final quarter of the year. Falling inflation would encourage the Bank of England to start cutting interest rates in June, they said.
However, progress on services inflation might slow due to stubborn wage growth and higher rents. “The outlook for 2025 is more uncertain, however, given more persistent effects from wage growth and rents,” the analysts cautioned.
Rent inflation makes up around 15 per cent of the wider services basket. Although it increased more slowly when prices started rising around two years ago, rent inflation now stands at a higher level and might prove sticky on the way down.
“While rents on new tenancies have been rising sharply since 2021, this has taken time to pass through to the average rent on the stock of outstanding tenancies…Moreover, the maximum increase in social rents is governed by lagged CPI inflation, generating a delayed pass-through from headline inflation to the CPI non-private rentals component,” Moberly and Stehn wrote.
Wage growth meanwhile, which is a key determinant of services inflation, has long been a concern for the Bank.
Although down from peaks of over eight per cent, wage growth remains far too high to be consistent with inflation falling sustainably to the Bank’s two per cent inflation target.
Some economists are concerned that a tight labour market could prevent wage growth from falling quickly, keeping cost pressures elevated. The Goldman analysts suggested that the pace of interest rate cuts will depend on the speed at which services inflation normalises.