UK Inflation Cools More Than Expected … Raising Fears?

From the tenor of financial commentary we have read lately, it seemed the only holiday gift the UK wanted this year was slower inflation … and they got it!^[i] Headline Consumer Price Index (CPI) inflation defied economists’ consensus expectations for an uptick by slowing from 3.6% y/y to 3.2% in November, with core CPI (which excludes food and energy) easing from 3.4% to 3.2%.^[ii] With the Bank of England meeting Thursday, one might logically expect slower inflation to spark a chorus of huzzahs for the slower-rising cost of living and prospects of an interest rate cut. But we find sentiment in the UK remains especially sceptical relative to other markets we track, which we suspect is why the groans and sighs outweighed the cheers as analysts warned slow inflation is another signal of an economy slipping into recession (a broad, lasting decline in activity). Yet from our vantage point, recession warnings have been a brick in the UK’s bull market wall of worry all year.^[iii] Even if the economy is slipping, the surprise power seems spent.

In a vacuum, it might seem odd for commentators we follow to cast slower inflation as a recession harbinger. Just two years ago, most of the developed world was begging for prices to stop galloping! And the UK has spent all year dealing with one of the developed world’s highest inflation rates, due largely to the household energy price cap’s failure to live up to its name.^[iv] A slowdown as food and apparel prices eased seems like it should be a relief.^[v]

But in the UK, inflation isn’t slowing in a vacuum. Last week, the Office for National Statistics announced monthly GDP (Gross Domestic Product, a government-produced measure of national economic output) contracted for the second straight month in October, slipping -0.1% m/m.^[vi] Then this week’s jobs data showed the unemployment rate rising to 5.1% in the three months to October, extending its climb from 4.1% in mid-2024 as both payrolls and the number of people reporting employment in the Labour Force Survey fell.^[vii] Against that backdrop, we saw many headlines interpret slowing inflation as a sign of weak demand and an economy losing what little steam it appeared to have.

We agree the UK economy has some soft spots, much as our research finds any national economy will have pockets of weakness as well as strength. The UK’s are getting a lot of attention this year, and we suspect this has to do with political reasons primarily, as economic data feed into the forecasts that determine how much the government must raise taxes or lower spending to meet its fiscal rules. When modest employer tax hikes took effect in April, we saw many, many headlines warn it would hit growth, which seemingly put everyone on alert for hints of confirmation. The UK economy remained under this metaphorical microscope in the run up to the Autumn 2025 Budget, unveilled late last month, which included more modest tax hikes.^[viii] Even though most of these take effect two or three years out, it adds to the spectre of fiscal policy crushing a weak economy. If Friday’s retail sales report isn’t pretty, another round of this chatter seems likely.

Yet this gloom is the backdrop for UK stocks rising 21.4% year to date, well ahead of the MSCI World Index.^[ix] Tax hike chatter, weak economy warnings, dreary data, they aren’t new. They were the norm for UK stocks all year, according to our coverage. And UK stocks had a banner year thus far.

Our research finds markets are efficient, rapidly pricing in all widely known information. UK stocks aren’t blind to any of this year’s economic discourse or data. We think they have been pricing it all year long. If the UK were on the cusp of a nasty recession, we think stocks would likely start signalling it well in advance. They aren’t, which strongly suggests the UK economy has some silver linings that aren’t getting much attention. That perhaps monthly GDP contractions aren’t unusual, slower inflation isn’t telling and maybe things aren’t really so bad.

Take, for instance, S&P Global’s flash UK purchasing managers’ indexes for December, which came out Tuesday. These business surveys, which measure the percentage of businesses reporting increased activity, showed across-the-board improvement. Manufacturing rose from 50.2 to 51.2 (readings over 50 indicate expansion), whilst services improved from 51.3 to 52.1.^[x] Together, these lifted the composite reading from 51.2 to 52.1.^[xi] It looks to us like activity has started picking up nicely now that Budget uncertainty is gone. Meanwhile, business lending has accelerated this year, hitting a high of 6.3% y/y in August.^[xii] Whilst it slowed since, we think October’s 5.6% y/y is nothing to sneeze at.^[xiii] The UK economy is quietly getting more fuel, enabled by a wider gap between short-term and long-term interest rates, which our research finds is a key economic indicator. If the BoE does cut Thursday, that gap likely gets even wider. Warnings of weakness abound, but fundamentals look far better.

So we suggest everyone take a deep breath. We don’t dismiss the UK’s challenges. Small businesses have had a tough time. Households have had to manage years of stealth tax hikes, as tax rate thresholds haven’t risen with inflation for years now. Power and water bills are up due largely to the aforementioned price cap and the fallout from the Thames Water crisis, respectively.^[xiv] But our research finds stocks don’t deal in absolute good or bad. We think they weigh reality relative to sentiment, and all year, the UK has shown stocks simply need things to be not so bad as gloomy projections imply.