Bank of England holds the line

Please note: The article does not constitute advice or any form of investment recommendation. All numbers quoted were sourced from Bloomberg data as at Thursday 1 February 2024. Past performance is never a guarantee of future performance.

New year, same old problems for the Bank of England (BoE): How to keep a lid on inflation without choking the economy? And how to cut rates without re-stoking the inflation fire?

In the first Monetary Policy Committee (MPC) meeting of 2024, members voted 6-3 in favour in keeping rates at 5.25%. Despite the split vote, it’s a case of four-in-a-row, with the BoE holding the line since the summer. 

On the plus side, there’s a market consensus that the peak rate has been reached. On the other hand, borrowers have faced rates at-or-above 5% since June, and they will be hoping for a cut sooner rather than later.

Same but different

While central banks operate independently of one another, and of government, a similar voting pattern is emerging between the US Federal Reserve (Fed), the European Central Bank (ECB) and the BoE. In the last two weeks, all three have voted to keep rates on hold: 4% in the case of the ECB, and 5.25%-5.5% for the Fed. 

In the aftermath of the ECB’s latest decision, President Christine Lagarde was at pains to caution that eurozone rates will need to stay high for longer, despite the worst of the inflation battle being over: “(It is) premature to discuss rate cuts…We need to be further along in the disinflation process¹.” The region’s economic prospects in 2024 look underwhelming, as growth stalls. 

Conversely in the US, the gravity-defying economy continues to show a resilience that has taken many forecasters by surprise. Economic growth remains robust, with gross domestic product (GDP) inching 3.3% higher in the last three months of 2023. In parallel, the US employment market is in good health, adding just shy of 170,000 new jobs in January. In the view of Treasury Secretary Janet Yellen, the country has achieved its much-desired “soft landing².” 

With peak rates seemingly reached in key economies, the timing of cuts is now under even more scrutiny. 

Always expect the unexpected

Despite the sting now removed from the inflation tail, there was a surprise in December when UK consumer prices nudged up to 4% (versus 3.9% in November 2023). It was a pre-Christmas reminder to the MPC that there is still work to do in order to meet its 2% target. 

Since then, tensions in the Middle East have also emerged, with supply-chain disruption expected from an increasingly perilous Red Sea. The re-routing of many cargo ships around Southern Africa is likely to hinder supply, and risks nudging prices back up. Tellingly, however, oil prices – which are often sensitive to Middle Eastern disputes and influential to global inflation – have remained relatively stable.  

On the political front, there is a growing belief that the Chancellor has seen enough progress in the inflation battle to consider wide-ranging tax cuts in March’s Spring Statement. Where Jeremy Hunt has been reticent to put more money in people’s pockets as price pressures soared – (for fear it would undo the BoE’s efforts) - he also knows that the UK economy could do with some stimulus. The fact that a General Election is also looming, will clearly be on his mind too. 

As the January MPC minutes stated, the uncertainty facing the UK is one reason why rate cuts are yet to happen, albeit they are edging closer: “Although services price inflation and wage growth had fallen by somewhat more than had been expected, key indicators of inflation persistence remained elevated. There were questions, on which further evidence would be required, about how entrenched this persistence would be, and therefore about how long the current level of Bank Rate would need to be maintained³.”

This uncertainty is somewhat reflected in the split vote, which saw two members favour an increase in rates, and one vote for an immediate cut.

In summary

Holding the UK base rate at 5.25% was a widely anticipated move by the BoE, against a backdrop of domestic and international influences that are delaying any cutting cycle.  

In the post-MPC press conference, Governor Andrew Bailey offered this synopsis:  “We have had some good news over the past few months. Inflation has fallen a long way, from 10% a year ago, to 4% now. Things are moving in the right direction but we have to be more confident that inflation will fall all the way back to the 2% target – and stay there. We're not yet at the point where we can lower interest rates⁴.”

While it leaves borrowers needing to wait a little longer for rate cuts to kick in, the worst does at least seem to be over. 

For the UK and US, our base case remains that Spring may herald the start of interest rate cuts (barring any major curveballs). Europeans will likely have to wait a little longer, with the summer signposted as a potential turning point. 

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