Inflation is back with a vengeance, surprising many economists and policymakers who thought it was a thing of the past. Just a year ago, the talk was all about rate cuts and economic recovery, with inflation seemingly vanquished. But now, with prices on the rise and inflation hitting 2.6 per cent in November, the outlook is much less clear.

The Bank of England (BoE) is facing a dilemma. On one hand, there is a need to stimulate the economy, which is showing signs of weakness. On the other hand, rising inflation is a cause for concern. The recent BoE meeting saw six members of the Monetary Policy Committee (MPC) voting to keep rates on hold, despite calls for a cut from some quarters.

The main driver of inflation seems to be surging energy prices, but other factors are also at play. Higher wage bills, Trump tariffs, and geopolitical tensions are all contributing to the price rise. Wage growth, in particular, has caught the attention of economists, with some predicting a sharper increase than expected.

The BoE’s own forecast for wage growth is in the range of 3 to 4 per cent in 2025, but some analysts believe this is too optimistic. Bank of America, for example, points to a significant jump in wage growth in October, suggesting that the BoE may be underestimating the impact of policy-driven increases in labor costs.

Despite the inflationary pressures, the economy is showing signs of weakness. GDP declined in September and October, while manufacturing contracted in October. The private sector is bracing for a steep decline in activity in the first quarter, according to the Confederation of British Industry.

The outlook for interest rates is uncertain. Some analysts believe the BoE will need to cut rates further to stimulate the economy, while others argue that inflationary pressures will limit the scope for rate cuts. Pantheon Macroeconomics, for example, sees a case for three rate cuts this year, including a 25 basis point cut in February.

In conclusion, the BoE faces a difficult balancing act as it tries to navigate between stimulating economic growth and controlling inflation. The path ahead is uncertain, with conflicting signals from the economy and the financial markets. The coming months will be crucial in determining the BoE’s next steps in managing the economy.