The good news is there has been a clear and consistent moderation in wage inflation over the past year or so. Yes, the National Living Wage was up by 9.8% year-on-year to £11.44 an hour in April. But these rises are less about the direct impact of the increase (which applies to only about 5% of workers) than about the extent to which pay differentials are maintained – in other words, how much the earnings of people on higher wages go up in response. Survey data suggest such increases are more contained this year than last.

Most pay surveys show wage inflation easing (% 3-month period year-on-year)

Employment and ‘activity’ (employment plus unemployment) rates have been rather volatile in recent years, but their overall trend has clearly been downwards since the pandemic. Although labour demand is not particularly strong at present, labour supply appears to be more constrained than in previous cycles. It’s uncertain how quickly supply will return given that much of the decline in work participation is due to the high number of long-term sick.

Inactivity, cumulative change since January 2020 (thousands of people)

Net inward migration to the UK has increased sharply since the pandemic, with the number of work visas being issued more than twice as high in 2023 as in 2019. Nevertheless, migrants coming to the UK to work tend to be heavily concentrated in the health and social care sectors, and there are wider skills shortages.

Survey data gauging the extent to which broader services inflation pressures are moderating – wage inflation is a key driver of services inflation – suggest there are ongoing disinflationary trends. The Services Purchasing Managers’ Index (PMI) survey of ‘prices charged’ has been falling since mid-2022 and is currently at levels consistent with Consumer Price Index (CPI) services inflation easing from 6.0% year-on-year in March to 4.2% by early 2025. But some further moderation in services CPI inflation – probably to 3.0-3.5% – will ultimately be required to be more confident about achieving the 2% CPI target sustainably. 

Still, progress over the past year suggests to us that the Bank of England (BoE) can safely begin to loosen monetary policy in the coming months.

Services PMI (left-hand side, index) and CPI services inflation (right-hand side, %)

When will the first rate cut come? Wage and services inflation are moderating, albeit only gradually, and most members of the Monetary Policy Committee (MPC) are sticking closely to the script that they will need more evidence of cooling domestic price pressures before cutting rates. 

Financial markets have shifted to pricing the first cut in August, in line with our long-standing forecast; until recently markets priced June, and even May, for the first reduction. At the June meeting the MPC will have to hand a first estimate of official wage data for April, the single most important month of the year for pay awards. 

However, wage data can be revision-prone during the spring and the latest rise in the National Living Wage may result in some policymakers wanting to see additional evidence before deciding what to do. We suspect policymakers will prefer to wait for August’s formal Monetary Policy Report and quarterly forecasts to evaluate the data more fully.

Expectations for policy easing have cooled in recent weeks, although UK market moves appear to be more a function of global (and particularly US) rate expectations than a reflection of changes in the UK macroeconomic data.

With the MPC waiting for clearer evidence, the BoE will inevitably be behind the curve when the policy easing cycle begins. Given the slower pass-through of monetary policy than in previous cycles due to the dominance of fixed-rate (and longer-maturity) mortgage products, a case can be made for the BoE to sanction larger initial rate cuts (in other words, 50bp rather than 25bp cuts). 

However, the still cautious tone conveyed by BoE rate-setters in recent weeks suggests to us that quarter-point increments are probably more likely. 

To speak with our market specialists about the interest rate outlook and what it could mean for your business, get in touch with your NatWest representative or contact us.