The Bank of England opens the door to rate cuts but calls for “further evidence” of falling inflation

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The Bank of England opened the door to interest rate cuts but said it first needed “further evidence” that inflation will continue to fall, as it held borrowing costs at 5.25%.

After a monetary policy committee meeting, the BoE signaled on Thursday that it was ready to consider cutting rates for the first time since the surge in inflation following the coronavirus pandemic.

With headline inflation now at 4% compared to a 2022 peak of more than 11%, the bank has abandoned its earlier warnings that “further tightening” of monetary policy may be needed. Instead, the BoE said it would “keep under review” how long rates should be kept at current levels.

The meeting marked a turning point, more than two years after the central bank embarked on an aggressive rate-hiking campaign that pushed borrowing costs to their highest level in 15 years.

BoE Governor Andrew Bailey said the bank had received “good news on inflation in recent months”.

But he warned: “We need to see more evidence that inflation is set to fall to the 2% target, and stay there, before we can lower interest rates.”

Bailey said that, with service price inflation still high and the negative contribution of falling energy prices set to fade in the coming months, the BoE cannot yet declare “the job is done”.

The BoE Bank Rate (%) line chart showing UK interest rates held for the fourth consecutive meeting

Traders scaled back their bets on spring rate cuts following the announcement. Swap markets were pricing in a roughly 55% chance of a reduction by May, down from 60% yesterday.

Both the US Federal Reserve and the European Central Bank have signaled in recent days that they will delay rate cuts until they have more evidence that inflation is fully under control.

Fed Chair Jay Powell said on Wednesday that the March cuts do not constitute his central bank’s “baseline scenario.”

In a sign of ongoing debate within the MPC, two members voted for further rate increases while another opted for an immediate cut. The majority voted to keep rates unchanged at 5.25% for the fourth meeting.

The benchmark FTSE 100 stock index moved little after the BoE announcement, rising 0.3%. The mid-cap FTSE 250 fell 0.4%.

The BoE expects consumer price inflation to “temporarily fall” to its target of 2% in the second quarter before rising during the rest of the year.

It warned that headline inflation will remain “above target for most of the remainder of the forecast period,” at 2.3% in two years and 1.9% in three years.

Those forecasts suggest the central bank is not expecting as aggressive a rate cut as some investors had speculated.

Line chart of UK CPI inflation (annual percentage change) showing the BoE forecast inflation would fall

The BoE’s new outlook is being closely monitored by Chancellor Jeremy Hunt, as a fall in borrowing costs could boost his chance of cutting taxes ahead of his March 6 budget.

But Hunt told the BBC he does not expect to have as much latitude for tax cuts as in November’s Autumn Statement, when he reduced national insurance contributions.

The BoE reiterated that monetary policy will need to remain “restrictive for a sufficiently long period” to sustainably bring inflation back to the 2% target.

The central bank stressed that although the labor market had cooled, with risks from domestic wage and price pressures now “more evenly balanced”, it remained “tight by historical standards”.

The BoE has updated its forecast for 2024 growth, which it now says will be 0.25%, up from its previous forecast of zero growth. Growth of 0.75% is expected for 2025.

Line chart of UK GDP (Q4 2019 = 100) showing the BoE has raised its medium-term growth forecast

MPC member Swati Dhingra called for a quarter-point cut in interest rates, saying inflation was now on a “firmly downward trajectory”.

His vote in favor of an immediate cut kicked off the MPC’s first discussion of the benefits of lowering rates since the rate-hiking cycle began in 2021.

Megan Greene, who has previously supported higher rates, aligned herself with the majority in supporting unchanged rates at the meeting. Two other MPC members – Jonathan Haskel and Catherine Mann – continued to call for a further quarter-point increase.

Additional reporting by Delphine Strauss

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