BOE likely to hold on rates, but weakening economy may force its hand in 2024

MOST economists predict that the Bank of England (BOE) will maintain its benchmark interest rate at 5.25 per cent on Thursday (Nov 2). As the UK struggles with stagflation, however, there are concerns that the central bank will have to cut rates in the first or second half of 2024.

The good news – favouring the unchanged 5.25 per cent forecast of 61 out of 73 economists in a Reuters poll last month – is that food and retail inflation numbers are falling.

The British Retail Consortium (BRC), which represents 200 major British retailers, said that annual shop price inflation fell to 5.2 per cent in October, from 6.2 per cent in September.

Food price inflation fell for the sixth month in a row to 8.8 per cent, from 9.9 per cent, and non-food inflation eased to an annual 3.4 per cent, from 4.4 per cent.

So, despite high energy prices and a weak pound, consumer price inflation is now expected to drop from the most recent level of 6.7 per cent.

The UK’s inflation level is still relatively high when compared against those of its trading partners in Europe, or against the US. It is, nevertheless, well down from the worrying October 2022 peak of 11.2 per cent.

“We expect unchanged guidance from the BOE, that rates will remain ‘sufficiently restrictive for sufficiently long’, but that ‘further tightening would be required if there was evidence of more persistent price pressures’,” Natwest economists said in a note.

Bad economic news should also placate inflation hawks in the BOE monetary policy committee (MPC), who have advocated for higher rates to swiftly slash inflation.

High mortgage rates have been a dampener on property prices, the building sector and other parts of the economy. The net effect is declining demand and limitations on the ability of businesses to raise prices.

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“The UK economy continued to skirt a recession in October,” said Chris Williamson, chief business economist at S&P Global Market Intelligence. “UK business activity declined for a third month running, suggesting that the economic malaise in September has spilled over into the fourth quarter.”

Williamson noted that both the manufacturing and services industries contracted in October: “The service sector’s output fell for a third successive month; consumer services remained under steep pressure, and transport slumped sharply; demand for financial services continued to slide, and business services contracted. Only the tech/IT sector reported higher output.”

The drop in October manufacturing output was the eighth in as many months, and employment in the sector has declined for 13 months. Services sector payrolls were also trimmed. The increase in unemployment should curb inflationary wage increases, he added.

There is still uncertainty on whether inflation can be conquered soon, as reflected in the prices of government bonds. The yield on 10-year gilts is 4.5 per cent – only slightly below the year’s high of almost 4.7 per cent.

BOE governor Andrew Bailey is sticking to the latest central banker fashions with the intention to keep interest rates at high levels for a lengthy period. The aim is to maintain the tight interest rate policy until inflation falls to a target level of 2 per cent.

At the International Monetary Fund meeting in Marrakesh in October, Bailey said that there were clear signs that the BOE was making good progress against inflation. He added, however, that there was a lot more to do. “The last mile really does lean heavily on... restrictive policy,” Bailey noted.

The problem was that the economic outlook appeared “very subdued”, he said, which limited monetary policy.

Indeed, continued weakness in the economy could very well force the central bank’s hand next year.

To reduce holdings of some £839 billion (S$1.4 trillion) worth of government bonds purchased during a period of acute monetary ease, the BOE has sold £80 billion of gilts in the 12 months to September 2023.

In doing so, it has sucked funds from the financial markets and economy. Bond yields rose and bond prices fell.

The MPC is in the process of selling a further £100 billion of gilts, and the impact is likely to be even tighter monetary supply. If that tight supply leads to a recession in 2024, the UK could see a period of falling interest rates.