Interest rate cut is good news – but there’s one group who won’t benefit ...Middle East

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Good economic news is rare this Christmas season, so the fall in the Consumer Prices Index – the rate of inflation as judged by the price of various household essentials – from 3.6 per cent to 3.2 per cent deserves a welcome.

It makes it a near certainty that the Bank of England will cut its interest rate from 4 per cent to 3.75 per cent when its monetary policy committee meets today. The decline in inflation was greater than the markets had expected, so the FTSE100 share index at one stage shot up by more than 150 points, close to its all-time high. The cost of government borrowing fell sharply too.

There is, as so often happens in economics, a catch – or rather, in this case, two catches.

The first is that the reasons for this sharp fall in inflation are temporary, such as early Black Friday discounting by retailers, a drop in airfares, the fact that tobacco duty was increased a month later this year than last, and so on. Underlying inflation in the huge services sector rose to 4.1 per cent, up from 4 per cent in October, and that is the indicator most closely watched by the Bank of England.

So expect inflation to go back up again in December and into the New Year, and if that does indeed happen, the scope for further cuts in interest rates will be very limited indeed.

The job market cools

While there may be some further trimming back of the interest cost of a mortgage next year, the decline is not likely to be substantial. Since inflation is still running well above the target rate of 2 per cent, it is possible that by the end of 2026 interest rates will be heading upwards again.

The second catch – and this particularly affects young people looking for entry-level jobs – is that the labour market is weakening. On Tuesday, the day before these inflation figures, the Office for National Statistics estimated that the number of payrolled employees had fallen by 149,000 between October 2024 and October 2025, with a decline of 22,000 between this September and October. Unemployment had risen to 5.1 per cent, the highest since early 2021.

What seems to be happening is not that there are large numbers of redundancies, but companies are instead trimming their staffing by cutting back on recruitment. So the increase in unemployment is disproportionately hitting young people starting out on their careers.

Entry-level jobs wiped out

This squares with other surveys. Graduate hiring is down 8 per cent year-on-year, according to a survey by the Institute of Student Employers. It is true that the number of apprenticeships has risen, but overall recruitment into entry-level jobs is down 5 per cent on the previous year.

The decline in graduate recruitment is not only a UK problem, for much the same is happening in Europe and North America. The driver seems to be the way in which AI is taking over entry-level tasks. This has been happening for at least two years, so it would be unfair to blame the present UK government for this phenomenon.

However the additional costs of employment, including the sharp increase last year of employers’ national insurance contributions (NICs), must to some extent have contributed to the fall in payroll employment. A hiring freeze is a less painful and cheaper way to trim staff levels than to make people redundant.

The year ahead

Looking ahead, three things seem likely to shape the economic outlook for 2026. One is indeed the pattern of inflation. If, after some increases in the early part of the year, it comes back to 3 per cent or below, then the path will be clear for two more cuts in interest rates after the one today. That would bring the Bank rate down to 3.25 per cent. That is the view of KPMG. Other market estimates, such as one from Goldman Sachs expect three cuts in rates, going down to 3 per cent by the end of 2026.

Inevitably there are also more cautious forecasts, suggesting that the bottom of this interest rate cycle could be 3.5 per cent. That would be the case if inflation does not come down significantly after the expected increases in the early part of the year, and instead becomes stuck at well over 3 per cent.

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The second thing is what happens to inflation in the world outside. If inflation, and hence interest rates, decline in the US and Europe, that makes it easier for the Bank to cut rates here. Rationally it ought not to matter what other countries do, but in the real world it does. So if the next chair of the US Federal Reserve manages to push down dollar interest rates, as the President would self-evidently wish, that clears space for us to do the same with sterling rates. If inflation heads up sharply elsewhere that is bad news for us too.

And third, there is the wider economic outlook. The best way to see this is to think of the UK as a member of a global convoy, sometimes steaming along a bit slower than the others, sometimes a bit faster. We are subject to the same forces. Currently the overriding external driver is technology, and in particular how AI affects both growth and jobs – for better or for worse.

So we should welcome any good pre-Christmas news, such as we have just had on inflation. But one set of encouraging numbers doesn’t clear the way for a brighter 2026. There is still a long slog ahead.

Need to know

The other thing that will affect 2026 is what on Earth will happen to share prices. Put bluntly, if there is a market crash in America, it would be naïve to expect us to escape unscathed. And if share prices here fall sharply, that will affect everything else – demand in the economy, consumer confidence, the housing market, the lot.

It is an American story, because US equities account for more than 60 per cent of global market capitalisation, and have since 2010 pretty consistently outpaced the rest of the world. There are some charts here that demonstrate this. But gauging the scale of the impact is really, really difficult. A serious pullback in US share prices – let’s say something short of a crash – would unsettle things here, but the links between markets and the real economy are fuzzy and the lags uncertain.

We know there is an economic cycle, and we know that there are equity market cycles, but we are not clever enough to be able to predict either. For what it is worth, the idea that the US should be entering a recession in the coming months is very much a minority one, and so far I have not found any mainstream US investment house predicting a bear market in equities in the year ahead.

Musing over all this – and I shall try and think further over the Christmas break – my instinct is that there may well be a fall in share prices in 2026, but I feel the next global downturn is still two or three years away. I am very worried about rising unemployment here in the UK, and it is impossible not to be troubled by the way in which AI is undermining the jobs market. So there are certainly elements of 2000, and the end of the dot-com boom. But this does not feel like 2008. We are not looking over a cliff.

As far as the UK is concerned, the best number to look at will be government tax revenue. If that holds up, then that’s a sign that the economy is still growing. The ONS now reckons that the most useful indicator of the job market is PAYE receipts, because that gives a real-time readout. If that falters – and it does seem to be weakening – then it is not only the Chancellor that should be worrying. But employment hasn’t collapsed. Fingers crossed it won’t in the months ahead.

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