Morgan Stanley adjusted its outlook on the Bank of England’s (BoE) monetary policy, citing recent inflation data that surpassed expectations.
The firm indicated that the UK’s headline inflation has reached its lowest point since July 2021, while core inflation has finally dropped to the 3% range. Despite these dovish indicators, April’s inflation figure, which is critical for the BoE’s short-term policy decisions, was higher than anticipated.
The analysis highlighted that the increase in core goods inflation aligned with Morgan Stanley’s projections, suggesting a softer detail behind the numbers.
However, service inflation presented a different scenario, with broad-based increases, especially in sectors sensitive to the National Living Wage (NLW), such as recreational and cultural services, catering, and hotels.
Morgan Stanley’s report also revisited the disinflationary process as envisioned by the majority of the Monetary Policy Committee (MPC) earlier in the year. It questioned whether the elevated pay growth, which surveys suggest will stabilize at around 4% next year, still remains a secondary concern given the unexpected rise in NLW-sensitive sectors.
The firm pointed out that while this inflation data is important, it is also typical for UK businesses to adjust prices in April. If this marks the end of significant price level adjustments, then the recent market repricing of UK interest rates may have been excessive.
Morgan Stanley anticipates that services inflation will adjust to approximately 5.4% year-on-year in May, with a potential for further increases due to NLW effects.
As a result of the latest data, Morgan Stanley has withdrawn its expectation for a rate cut by the BoE in June. The firm now views August as the earliest feasible date for a rate reduction, although it admits its conviction is not strong.
This stance is influenced by the upcoming change in the MPC’s composition and the need for more evidence on the services inflation trend.
Looking beyond the immediate term, Morgan Stanley has made no significant changes to its structural outlook based on just one inflation report.
The firm maintains its forecast of a total 75 basis points cut in interest rates by the BoE this year, with reductions likely occurring in September and November.
The medium-term inflation outlook has been slightly adjusted, with headline inflation forecasts for 2024 and 2025 increased by 10 basis points to 2.5% and 1.9%, respectively.
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