Bank of England: Too soon to take foot off interest rates

The Bank of England has not moved the interest rate in its latest Monetary Policy Committee meeting despite some improvements to the inflation outlook.

The Bank of England has not changed the UK interest rate from 5.25%.

The Bank of England (BoE), which sets monetary policy for the UK, has not moved interest rates from 5.25% at its latest monthly meeting, citing international geopolitical tensions as part of the reason.

Thursday saw the latest meeting for the BoE’s quarterly Monetary Policy Report, which sets out the economic analysis and inflation projections that the Monetary Policy Committee (MPC) uses to make its interest rate decisions.

According to the MPC’s December report, the twelve-month CPI inflation fell to 4.0% in December 2023 in the UK, which was down heavily from the recent peak. However, the committee has not moved the interest rate despite this improvement and some pressure from areas such as the government and the financial sector – though many others were also in favour of the more cautious approach.

The nine-member MPC vote in February was: six in favour of unchanged rates, two in favour of increasing rates by 0.25 of a percentage point, and one in favour of cutting rates by 0.25 of a percentage point, according to the government's report on the process.

Numerous reasons were given for the decision to not move the interest rate, despite pain for mortgage holders being widely publicised in the UK’s media. The statement said that since the MPC’s previous meeting, global GDP growth had remained subdued, although activity continues to be stronger in the US.

The MPC’s report continued, saying that inflationary pressures were abating across the euro area and the US, and that wholesale energy prices had fallen significantly.

However, material risks remain due to developments in the Middle East and disruption to shipping through the Red Sea, which could interrupt global supply chains, seeping through into construction, manufacturing, and retail sectors, and potentially leading to spikes in inflation.

Labour market offers conflicting signs

The UK’s labour market was also taken into consideration in the decision, with no widespread unemployment event despite recessionary conditions over the past two years. “The labour market has continued to ease,” it said, “but remains tight by historical standards.”

The MPC said that in its February Report projections, it highlighted the continuing relative weakness of demand, despite subdued supply growth by historical standards, which would likely lead to a margin of economic slack emerging during the first half of the forecast period. Unemployment is expected to rise somewhat further, they said.

Currently, the UK employment rate (for those aged 16 to 64 years) increased by 0.1 percentage points on the quarter to 75.8% in January 2024, according to the UK’s Office of National Statistics.

The UK unemployment rate (for those aged 16 years and over) was largely unchanged on the quarter at 4.2%.

Job vacancies decreased on the quarter but are still above pre-pandemic levels, and annual growth for nominal earnings in both total (including bonuses) and regular (excluding bonuses) earnings continued to be strong, “but not as strong as recent periods” the latest report said.

All this showed an overall strong performance in the labour market, which could fuel the BoE’s hesitancy around the cuts.

Other inflationary areas, such as housing, were also going strong. It was announced this week that UK house prices increased at the strongest rate in a year. Nationwide, a leading mortgage lender, said that "though rapid rebound is unlikely, outlook for property market ‘is a little more positive'."

Elsewhere, the average price of petrol across the UK reduced by 6p a litre in December from 146.69p to under 141p (140.58p), making for two consecutive monthly falls, said data from motoring analytics site RAC Fuel Watch.

“Higher interest rates are working to reduce [inflation],” said the statement at the meeting. “Inflation could fall to our 2% target within a few months, before rising slightly again. We will keep interest rates high for long enough, so inflation settles at 2%.”

“We will keep interest rates high for long enough to get inflation
back to the 2% target in a lasting way."

The BoE boss believed that the course to lower inflation was doing its job and would continue as long as it was needed. “We have raised interest rates over the past two years to help slow down price rises (inflation). It’s working,” said Andrew Bailey, BoE Governor, on the decision. “Inflation in the UK has fallen from a peak of 11% in 2022 to 4% in December 2023.”

“But inflation is still above our 2% target. High inflation affects everyone, but it particularly hurts those who can least afford it. We need to make sure it comes down further.”

He added that the BoE expected inflation to fall, “though with some bumps along the way. It could briefly drop to 2% in the spring, before increasing slightly again”. 

“We will keep interest rates high for long enough to get inflation back to the 2% target in a lasting way,” he said.

There was industry response that specified it was largely good news around inflation but that persistent risks remained.

“Despite a three-way voting split among the MPC, the BoE’s message was clear in the sense that disinflation is progressing but it’s too soon to declare victory,” said Neil Mehta, Portfolio Manager at RBC BlueBay Asset Management. “Some market participants were looking for a more dovish outcome into the meeting, owing rather to global factors since mid-December, but we think the BoE rightfully steered the narrative to domestic matters.”

“Even by their own forecasts, inflation will be at 2% in the summer,
but rise again towards 3% by year-end."

Mehta added that with services inflation and wages still growing above 6% year-on-year, the conversation regarding interest rate cuts was “rightfully kicked down the road”.

“Even by their own forecasts, inflation will be at 2% in the summer, but rise again towards 3% by year-end – a substandard outcome that does not meet the Bank’s target of 2% inflation on a ‘sustainable’ basis,” he said. “The BoE are in no rush while keeping their options open, and investors should be wise not to buy Gilts prematurely.”