Falling US inflation opens door to rate cuts within months, says OECD

A rapid fall in US inflation has opened the way for interest rate cuts within months, the OECD said, but it warned that Britain would suffer from the G7’s fastest price growth.

The OECD’s interim outlook, published on Monday, predicted US inflation of just 2.2 per cent in 2024 and 2 per cent in 2025 — among the lowest rates in the G7. The Paris-based organisation said that only in Italy would price growth be less this year.

But it forecast the UK would be burdened by the G7’s highest inflation rate, at 2.8 per cent this year and 2.4 per cent in 2025, underscoring the battle faced by the Bank of England in reining in price growth.

Although inflation is falling across the world in the wake of interest rate rises, the threat has not subsided, with a US jobs report last Friday rekindling fears that the country’s labour market remains too hot for rapid rate cuts.

“The big issue is still inflation and it seems to be coming down . . . consistently,” said Clare Lombardelli, OECD chief economist. But she added: “We are not out of the woods yet, and there is a fair way to go.”

The OECD said inflation would fall to most G20 countries’ target rates by the end of 2025. It predicted that central banks would be able to start reducing interest rates sooner than it said in its previous economic outlook in November.

The club of the world’s rich economies added that central banks could begin cutting rates in the US by the second quarter and in the euro area and the UK in the third quarter.

Federal Reserve chair Jay Powell said at the weekend he expected the US central bank to make about three quarter-point cuts this year.

But the OECD warned that policies “should remain restrictive for some time to come”, suggesting policymakers should not slash rates back to the near-zero levels of before the pandemic.

The US will have the most buoyant growth this year, with gross domestic product expanding faster than the other G7 countries at 2.1 per cent due to strong household spending and labour market conditions, the OECD said.

Germany is set for the weakest expansion in the G7 this year at just 0.3 per cent, the OECD said. The UK’s GDP will expand by 0.7 per cent in 2024 and 1.2 per cent in 2025, it forecast.

Core inflation, which strips out food and fuel, will be 3.6 per cent in the UK this year and 2.5 per cent in 2025.

The global economy is projected to expand by 2.9 per cent in 2024, marginally faster than the OECD previously projected, before picking up further to 3 per cent in 2025 as financial conditions ease.

The OECD left its outlook for Chinese growth unchanged, forecasting an expansion of 4.7 per cent this year and 4.2 per cent in 2025, a slowdown from 2023 that reflects subdued consumer demand, high debt and the country’s weak property market.

Among the biggest economic risks are “high geopolitical tensions”, the OECD said, including the danger that the Israel-Hamas conflict spreads across the Middle East and disrupts energy markets. It found that the recent doubling in shipping costs stemming from Red Sea disruptions could add 0.4 percentage points to inflation after a year. 

Stubbornly high services price growth is another risk on the radar, the OECD said, because it could generate “upside inflation surprises and trigger financial market repricing” as expectations of an easing in monetary policy are reassessed.