Standard Chartered strategists Christopher Graham and John Davies report that rising labour market slack and weak domestic demand in the UK may reduce the risk of second-round inflation effects. They link this to lower wage bargaining power among workers and weaker pricing power among firms than in the post-COVID period.
Vacancies are at their lowest level in more than 10 years, and payrolls have fallen by 120k over the past 18 months. These conditions point to less pressure for wage rises and fewer opportunities for firms to pass on higher costs.
Uk Labour Market Slack And Inflation Risks
They also say broad fiscal support to offset higher energy prices now looks less likely than it was in 2022–2023. In those years, support measures may have extended the inflation shock while reducing downside economic risks.
They add that the current macroeconomic environment differs from the one seen in 2022 and 2023. They note there is precedent for looking through energy price shocks.
With the UK labour market showing clear signs of slack, we should reconsider the stickiness of inflation. Current data from the Office for National Statistics shows job vacancies have fallen below 900,000 for the first time since 2021, and payrolls have been stagnant. This environment significantly reduces workers’ ability to demand higher wages and limits firms’ power to pass on costs, suggesting inflation will cool faster than expected.
Given this backdrop of fragile domestic demand, rate-sensitive positions should be adjusted. UK retail sales volumes showed a mere 0.2% growth in the last quarter, indicating consumers are cautious and unlikely to fuel a demand-led inflation spike. This weakness supports the view that the Bank of England has room to be more dovish, creating opportunities in short-term interest rate derivatives.
Positioning For Lower Uk Rates
We should not expect a repeat of the massive government support we saw back in 2022 and 2023. Back then, fiscal programs like the Energy Price Guarantee cushioned the economic blow but also prolonged the inflationary shock. With UK public sector net debt now hovering around 98% of GDP, there is little appetite or capacity for similar broad-based fiscal stimulus this time around.
This means we should look to position for lower UK interest rates over the medium term. The SONIA futures curve may be underpricing the potential for rate cuts later this year and into 2027. We see value in receiving fixed on 2-year interest rate swaps, betting that the Bank of England will need to act sooner or more decisively than the market is currently pricing.
This dovish outlook for the Bank of England should also weigh on the pound sterling. When compared to the Federal Reserve, which is grappling with a more resilient US economy, the policy divergence is likely to favour the dollar. We should therefore consider buying GBP/USD put options to hedge against or profit from a potential decline in sterling through the summer.
Lower interest rates would provide a tailwind for UK equities, which have underperformed other major indices. To capitalise on this, we can look at buying call options on the FTSE 100 index. A more accommodative central bank policy could easily spur a rally as borrowing costs for companies fall and investor sentiment improves.
