Bank of England signals rate cuts possible once inflation eases
THE Bank of England opened the door to interest-rate reductions, slashing its outlook for inflation this year and dropping its guidance that borrowing costs may have to rise again.
The UK central bank’s nine-member Monetary Policy Committee (MPC) split three ways on how to act, with a majority of six opting to leave the key rate unchanged at 5.25 per cent. Swati Dhingra pushed to cut rates, the first vote for a reduction since the start of the pandemic almost four years ago. Two others wanted a rate hike.
The decision marked the widest division on the direction of policy since 2008, a potential turning point in the BOE’s fight against inflation. Governor Andrew Bailey said cuts are now under consideration, stepping back from remarks in December when he said there was a way to go before price pressures are contained.
“We have had good news on inflation over the past few months. It has fallen a long way,” Bailey said in a statement on Thursday (Feb 1) that accompanied the decision in London. “But we need to see more evidence that inflation is set to fall all the way to the 2 per cent target and stay there before we can lower interest rates.”
The BOE’s more dovish stance was reflected in its guidance. The comment that “further tightening would be required” if inflation proved persistent was dropped. Instead, it reiterated that rates will need “to remain restrictive for sufficiently long to return inflation to the 2 per cent target.”
The committee said it “had judged since last autumn that policy needed to be restrictive for an extended period of time.” It added that it will “adjust monetary policy as warranted by economic data” and keep how long to leave rates unchanged “under review.”
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Forecasts in its February Monetary Policy Report also pointed to looser policy. On the constant rate path, which assumes the benchmark lending rate sticks at 5.25 per cent, inflation falls well below the 2 per cent target to 1.4 per cent at the two-year horizon and 0.9 per cent in three years. That suggests policy is much too tight.
Using the market path for rates to be cut to 4 per cent this year and 3.5 per cent in 2025, inflation is above target after two years, at 2.3 per cent, but dips to 1.9 per cent at the three-year horizon. That appears to imply rates should fall, but not as quite as steeply as the market thinks.
The UK has been lagging behind the US Federal Reserve and the European Central Bank, both of which have signalled that rate cuts are probable in the months ahead. Until now, the BOE has stuck to its warning that rates are more likely to rise than fall.
The UK economic backdrop has transformed since the BOE last met in December, with inflation dropping more sharply than anticipated. Officials now believe consumer-price inflation will be at the 2 per cent target in the second quarter, thanks to tumbling energy prices. That’s more than a year earlier than the BOE projected at its last forecasting round in November.
However, inflation then is likely to bounce up to almost 3 per cent as the impact of cheaper energy fades and underlying prices pressures in services and wages persist. The BOE cautioned that inflation risks remained “skewed to the upside,” and disruption in the Red Sea posed a potential price threat.
Lower inflation and rates buoy the economy. The BOE expects an expansion of 0.25 per cent this year, up from near zero in November. For 2025, the economy could show 0.75 per cent growth, also stronger than before – reflecting an easing of the cost-of-living crisis. About two thirds of the impact of higher rates since the tightening cycle began in December 2021 has now come through, the BOE said.
The MPC was deeply divided over how to act. Dhingra voted to cut rates to 5 per cent, arguing that there’s now a risk of overtightening. Catherine Mann and Jonathan Haskel stuck with their previous decision to raise rates to 5.5 per cent. Megan Greene, who had voted for a hike in December, rejoined Bailey with the majority opting for no change.
Not since summer 2008 have the MPC members voted for a rate rise, a rate cut and a hold at the same meeting. In August, a month before the MPC ended its quickest round of rate hikes in decades, the committee split three ways but the division was over the pace of rate rises.
In its annual supply-side stocktake, the BOE raised its estimate of the economy’s speed limit. It now puts potential supply growth at around 1.25 per cent on average over three years, up from less than 1 per cent when the assessment was made a year ago. BLOOMBERG
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