Bank of England Forecasts Lower Interest Rates, Anticipates Economic Adjustment

 

Interest rates have peaked. The next move in borrowing costs will be down. But not yet. Those were the three key messages from the Bank of England in its latest assessment of the state of the economy.

Those conclusions may not be immediately apparent from the minutes of the latest meeting on Threadneedle Street of the monetary policy committee (MPC) – the body tasked with setting interest rates to hit the government’s 2% inflation target – because the MPC had a three-way split.

Six members voted to keep interest rates unchanged at 5.25%, two voted for them to rise to 5.5% while one voted for a reduction to 5%.

 

It is rare for the Bank to be this divided, and in theory rates could still rise further. Interestingly, the last time there was a similar difference of opinion was in August 2008, the month before the collapse of the US investment bank Lehman Brothers ushered in the most turbulent phase of the global financial crisis. Rates were subsequently cut aggressively.

A repeat of the rapid easing of policy seen in 2008 is not on the cards right now, but the financial markets will read the runes. Assuming the economy pans out according to the Bank’s forecasts, the City will be pencilling in a cut in rates in late spring.

In November last year, the MPC said it stood ready to raise interest rates should inflationary pressure prove more persistent. In fact, there has been better news on inflation and that language has now been dropped.

What’s more, the Bank’s forecasts show that leaving rates at 5.25% would push the UK into a two-year recession lasting until the end of 2025 and for inflation to be well below its 2% target. Given those projections, it would be a little strange for the Bank to pretend that no discussions were taking place on the possibility of rate cuts.

On the other hand, the fact that inflation peaked at more than 11% and has taken time to come down inevitably makes the Bank cautious about easing policy too quickly. The MPC is particularly focused on the level of pay settlements and inflation in the service sector – both of which are seen as good bellwethers of underlying price pressures.

Andrew Bailey, the Bank’s governor, voiced the view of the no-change majority when he said more “good news” on inflation was required for rates to be cut.

The Bank has been surprised by the extent to which price pressures have eased in recent months and it now believes lower energy prices will bring inflation temporarily back to its 2% target by May. But it then thinks it will rise again to 2.75% by the end of the year. “We need to see more evidence that inflation is set to fall all the way to the 2%, and stay there, before we can lower interest rates,” Bailey said.

But as with other central banks – the US Federal Reserve and the European Central Bank – the question is not whether rates have further to rise but when it will be safe for them to be cut.

Read also:

Market Predictions Point to UK Interest Rate Cuts in 2024 Amid Recession Concerns

 

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