Where to next for UK and European rates?

Global markets have experienced the most rapid and aggressive rate hiking cycle of this century. Remarkably, global economic conditions have remained resilient. Labour markets have been robust, consumer spending has held strong, and we are yet to see anything meaningful in the way of defaults. All the while, inflation continues to trend back toward target bands; however, with cracks appearing across the UK and Europe, the key question is how will policymakers respond?

To address this, it is worth reflecting on two key pillars driving rate decisions: inflation and labour markets. While inflation has significantly declined from the peaks of 2022 and 2023, this year has not brought the level of relief markets anticipated. Services inflation remains particularly sticky, largely as a result of the labour-intensive nature of the sector. We expect that softer labour markets will be necessary to bring services inflation back in line.

In what may be a relief to policymakers, weaker labour market data is exactly what we have begun to see. In Europe (most notably in Germany and France) and in the UK, job vacancies have trended considerably lower over the last year, and unemployment rates are slowly creeping higher. This will eventually flow through to services inflation but, more importantly, it has afforded policymakers the flexibility to cut rates.

ECB initiate the first cut earlier this year, and the BoE follow last week. We expect the ECB to continue lowering rates over the next 12-18 months, ultimately settling around 2.25%. As for the BoE, we anticipate at least one more cut by year-end, with more to follow next year, settling around 4.0% in the latter half of 2025.