What’s next for interest and inflation rates?

Over the past couple of years, it’s been difficult to escape headlines detailing the UK’s shifting interest and inflation rates.

Indeed, after several significant global events, including Covid-19 and Russia’s invasion of Ukraine, the Consumer Prices Index (CPI) reached a 41-year high of 11.1% in October 2022.

In response to a post-pandemic rise in inflation, the Bank of England has increased the base rate 14 times in hopes that this would combat sharply rising living costs.

This interest rate policy has been successful, as after increasing the base rate to 5.25% in August 2023 and maintaining it at this level after three consecutive Monetary Policy Committee (MPC) meetings, inflation fell to 4% in the year to December 2023.

Changing inflation and interest rates could affect your financial plan, so having an idea of how they may move in 2024 could help you prepare your finances for more changes.

Continue reading to discover some expert predictions for inflation and interest rates in 2024.

Inflation could drop even more in 2024, though it may remain above the Bank of England target

As you read above, inflation rose to record highs of 11.1% in October 2022. The Office for National Statistics states that this was primarily due to increasing energy and food costs, largely resulting from Russia’s invasion of Ukraine.

However, after reaching 11.1%, the CPI started to drop in 2023, eventually reaching its current level of 4%.

It’s worth pointing out that inflation rose from 3.9% in the 12 months leading to November 2023 to 4% a month later, primarily driven by increases in the price of alcohol and tobacco.

Despite this bump in the road, the CPI still fell by more than expected towards the end of 2023, and economists believe it’s still on track to meet the BoE’s 2% target.

Lalitha Try, an economist at the Resolution Foundation thinktank, explained: “This serves as a reminder that bumps in the lower inflation road are inevitable, but does not change the big picture that price rises are coming in much lower than the Bank of England expected as recently as November”, the Guardian reports.

While the current CPI is still above the BoE’s target of 2%, declining inflation could be a welcome indication that it could reach this aim within the next few years. In fact, the BoE itself expects inflation to reach the 2% target by the end of 2025.

Some experts have even revised their forecasts recently, believing inflation could fall more quickly than this. For instance, the Guardian reveals that:

Oxford Economics predicts the CPI to average 2.1% over 2024, down from 3.1% in a forecast made in November
Deutsche Bank forecasts inflation to drop slightly below 2% in April and May, before hovering around 2% to 2.5% for the remainder of the year.

It’s important to remember that falling inflation doesn’t directly translate into a direct drop in prices; instead, the price of goods and services will rise more gradually.

Falling inflation can mean that the returns on your savings and investments are more likely to keep pace with cost of living rises, retaining their value in real terms. It also means that your household budget will likely be placed under less strain from spiralling prices.

It’s important to consider how inflation is affecting specific sectors

The BBC reveals that falling petrol and energy costs were the main contributing factors behind the falls in inflation towards the end of 2023.

Though, it’s worth noting that outside the energy sector, prices were still rising sharply in some areas. Data reported by Statista shows that, for the 12 months leading to December 2023, the inflation rate for specific sectors included:

12.9% for alcoholic beverages and tobacco
8.5% for communication
8% for food and non-alcoholic beverages
7.3% for health.

While falling inflation is undoubtedly a positive sign, just remember that your day-to-day costs could still climb more than the overall rate of inflation may initially indicate.

The BoE has frozen the base rate since August 2023, and could reduce it in 2024

When inflation is high, the BoE typically increases the base interest rate to encourage you to spend less and save more, reducing the demand for certain goods and services. This should, in theory, slow inflation down.

While the current base rate of 5.25% – a 15-year peak – may seem disproportionately high, it’s essential to keep the historical data in mind. The period following the global financial crisis in 2008 saw interest rates in the UK fall to record lows. For instance, it fell to just 0.1% in March 2020.

These lower rates became the “new normal” in the UK, and as a result, many borrowers managed to secure competitive repayment rates on mortgages and other forms of debt.

It wasn’t until inflation started climbing significantly following the pandemic that the BoE began to increase the base rate, eventually reaching its current level of 5.25%.

A higher base rate means that borrowing costs rise – for example, your mortgage repayments may have jumped if you’re not on a fixed rate. It also means that the interest you receive on your savings should also rise.

While the frozen base rate is a positive sign, it’s still worth preparing for higher-for-longer interest

While the BoE increased interest rates 14 times to bring inflation under control, it’s worth remembering that it has frozen the rate at its current level since August.

This may be a healthy indication that the BoE is starting to get inflation under control and that the base rate could start dropping in 2024. In fact, Unbiased believes that if inflation continues to decline this year, the base rate could possibly fall to 4% by the end of 2024.

Meanwhile, Morgan Stanley forecasts that the BoE could reduce the base rate to 4.25% by the end of 2024, and the first cut could arrive as soon as May, while Goldman Sachs predicts the first interest rate cut to come as early as February, This is Money reports.

Even if interest rates do fall in 2024, it’s likely that they will remain higher than they have been over the last 15 years or so. So, if you have a mortgage deal coming to an end this year, or you’re looking to take out a mortgage in 2024, it will likely cost more than it would have before the pandemic.

Falls in interest rates will also likely result in a reduction in the returns you receive from cash-based investments, so it may be necessary to review your portfolio to ensure you maximise your potential for growth.

Remember: it is difficult to accurately forecast how inflation and the base rate may move. Even though several experts have made predictions, a significant global event could mean that inflation and interest rates move unexpectedly.

For example, even in recent months, several shipping firms have stopped vessels using the Red Sea route after Houthi rebels in Yemen attacked ships.

This could have an inflationary impact in the UK due to increased global shipping costs and rising oil prices. Consequently, any rise in inflation could keep interest rates higher for longer.

However, with inflation dropping significantly over the past year, and as the base rate could ease in response, things are already looking slightly brighter in 2024.