For the first time since the beginning of the coronavirus pandemic, the Bank of England opened the door to cut interest rates, confirming forecasts that the inflation rate will reach the target level in the coming spring, and warning of the likelihood of renewed price pressure.
The central bank of the United Kingdom has removed key guidance that the cost of borrowing may have to be increased again. The governor of the Bank of England, Andrew Bailey, said that keeping interest rates at the same level would lead to the inflation rate falling below the target of 2%.
The Monetary Policy Committee, which is part of the structure of the financial regulator of the United Kingdom and consists of nine members, was divided into three opinions on how to proceed. At the same time, six members of the committee preferred to keep the key rate at 5.25%, without making any decisions on changing this indicator.
A member of the Monetary Policy Committee, Swati Dhingra, stated the need to reduce rates. This is the first such point of view in almost four years. Catherine Mann and Jonathan Haskel announced the need to raise interest rates to 5.5%.
Traders are convinced that during this year the Bank of England will make at least four decisions to reduce the mentioned indicator by a quarter point. It is expected that the financial regulator of the United Kingdom will begin implementing the relevant policy no earlier than June. The probability of a reduction in interest rates in May is about 50%.
Yael Selfin, KPMG’s chief UK economist, says cuts could occur starting in the summer. According to the expert, the reduction in interest rates in 2024 may amount to about 100 basis points. Yael Selfin also expects this figure to reach 3% by the second half of 2025.
Strategists perceived the officially declared position of the Bank of England regarding the prospects for lowering the interest rate as tougher than preliminary expectations. The pound sterling weakened slightly against the euro and the dollar but on a non-critical scale. The yield on 10-year bonds showed a decrease of two basis points, to 3.78%.
The Monetary Policy Committee has demonstrated what can be described as evidence of a lack of unity on the strategy for further action. This disparity of points of view is being recorded for the first time since 2008. Currently, the Bank of England is approaching a kind of turning point in the fight against inflation. In recent weeks, the United Kingdom’s financial regulator has been under pressure to force it to adjust its hawkish stance compared to the Federal Reserve and the European Central Bank. On Thursday, February 1, Andrew Bailey abandoned his previous position, saying that there is a way to go before price pressure is contained.
For the Governor of the Bank of England, one of the unknown factors that could change the prospects for lowering interest rates is the potential stimulus coming from the government of the current Prime Minister of the United Kingdom, Rishi Sunak, in the next budget.
Chancellor of the Exchequer Jeremy Hunt is preparing a statement to be made publicly in early March and wants to find opportunities for tax cuts that can potentially become a source of positive influence on positions of the ruling Conservative Party in public opinion polls, which is extremely important for this political force in the context of confrontation with the Labour opposition.
Henry Cook, senior economist at MUFG in the EMEA region, expects that the UK leadership will implement some personal income tax cuts. According to the expert, the relevant decision will be made within the framework of the upcoming budget. Henry Cook says that in the coming months, a softer fiscal policy may be opposed to the restrictive monetary policy of the Bank of England. The expert also noted that the Chancellor of the Exchequer tried to downplay speculation around pre-election budget giveaways.
The financial regulator has abandoned its previous recommendations that further policy tightening will be required if inflation proves to be more stable. The Bank of England currently adheres to the position that interest rates should remain restrictive for a long time to return inflation to the target of 2%.
Forecasts in the financial report on monetary policy indicate a softening. With the rate unchanged, which maintains the base lending rate at 5.25%, inflation will decrease below the target figure of 2% and amount to 1.4% in the two-year term and 0.9% in three years. These prospects suggest that the current version of monetary policy is too tight.
Inflation will exceed the target of 2.3% in two years but will decrease to 1.9% in the three-year term if a market approach is used to reduce rates to 4% in 2024 and 3.5% in 2025. The Bank of England is guided by these prospects, which should probably be interpreted as a statement of intention to ease monetary policy, but not as rapidly as the market expects.
Kamal Sharma, a strategist at Bank of America, says that despite the vote for an immediate rate cut, there is still a hawkish stance compared to what was priced in. According to the expert, the inflation forecast of 2.3% by 2026 should be interpreted as a signal from the financial regulator of the United Kingdom that the goals for increasing the cost of goods and services and raising rates have not yet been achieved.
The UK is lagging behind the Federal Reserve and the European Central Bank, which have indicated the likelihood of monetary policy easing in the coming months. Until February, the Bank of England maintained the position that rates are likely to rise rather than fall.
Dan Hanson and Ana Andrade, Bloomberg Economics, say that the financial regulator of the United Kingdom warmly welcomes the idea of the possibility of lowering interest rates in 2024. According to them, the next step is likely to be down, which is hinted at by a vote for a cut, softer guidance, and a forecast that supports the brainchild of multiple rate reductions this year. Experts say that the base scenario is the first decline in May.
The economic background of the UK has changed since the last meeting of the Bank of England in December. Since then, inflation has shown a decline that has turned out to be sharper than the initial expectation. Officials expect consumer price inflation in the United Kingdom to reach 2% in the second quarter of 2024, amid lower energy costs. It is worth noting that the Bank of England in November predicted reaching the mentioned level more than a year later.
At the same time, the positive impact of lower energy costs is gradually weakening, which is why there is a possibility of inflation rising to almost 3%. This outlook is also driven by factors such as underlying price pressures on services and wages, which continue to persist.
The Bank of England warned of an upward shift in inflation risks, separately noting the tense situation in the Red Sea, which negatively affects world trade, and creates a price threat.
Andrew Bailey said that keeping the bank rate at 5.25% for three years could trigger a drop in inflation well below the target level. He noted that the use of a market regulation mechanism, in this case, would be the reason that the growth in the cost of goods and services over most of the next three years would be significantly higher than the target mark.
Lower inflation and interest rates support the economy. The Bank of England expects growth of 0.25% this year. In November, the financial regulator of the United Kingdom predicted almost zero growth. The Bank of England expects this positive dynamic to reach 0.75% in 2025. These forecasts indicate an easing of the cost-of-living crisis.
The Bank of England claims that about two-thirds of the effects of rate hikes since the start of the tightening cycle in December 2021 have now come through.
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