The Monetary Policy Committee (MPC) of the Bank of England (BoE) decided on Thursday to leave the benchmark interest rate at 5.25%, the highest since 2008, for the second consecutive meeting. At the September meeting, the central bank decreed the first after a year and a half of uninterrupted hikes that have led to a tightening of 515 basis points. The agency seems to want to settle on the ‘plateau’ drawn a few months ago by its chief economist, although the decision has been divided.
This summer, Huw Pill, the BoE’s chief economist, made headlines with the ‘plateau’ metaphor. Setting out the direction central banks should take in the wake of the inflation crisis, the Briton said they could opt for a ‘Matterhorn’ path, the craggy peak in the Alps on the Swiss-Italian border (also known as the Matterhorn), or a ‘Table Mountain’ path, a reference to the elevation topped by a broad plain above Cape Town, South Africa.
If the first case implied abrupt rate hikes to ‘break’ the economy and quickly bring inflation to its knees and then quickly lower rates; the second, the one advocated by Pill as the path to be followed by the BoE, implied maintaining high rates for a longer period of time until their effects are fully transmitted to the economy. The latter path would correspond to the higher for longer (higher rates for longer) that has been used recently by the US Federal Reserve (this Wednesday it approved its second consecutive pause as well) and the European Central Bank (it proceeded to its first pause of the cycle last week and most analysts agree that the ceiling has already been reached).
The BoE’s decision on Thursday sends a clear message that the central bank prefers to scale Table Mountain despite recent inflation and wage pressures data not quite clearing the runway for the agency’s officials. However, the split in the Monetary Policy Committee when it came to vote on the decision (6-3 in favor of the pause) shows that there is a temptation for some members to keep climbing. The three ‘fractious’ members voted in favor of a further 25 basis points hike that would take the benchmark rate to 5.5%.
Interest rate developments in the United Kingdom
“The MPC will continue to monitor closely signs of persistent inflationary pressures and resilience in the economy as a whole, including a range of measures of underlying tightness in labor market conditions, wage growth, and services price inflation. Monetary policy will need to be tight enough for long enough for inflation to return to the 2% target on a sustainable basis over the medium term, consistent with the Committee’s mandate. The latest projections indicate that monetary policy is likely to need to be tight for an extended period. Further monetary policy tightening would be needed if there were evidence of more persistent inflationary pressures,” the BoE statement said, welcoming the level of rates, but not closing the door to additional hikes.
“The BoE’s decision to hold rates at 5.25% for the second consecutive meeting and the reaffirmation of the message that rate cuts are a long way off supports our view that the Bank Rate will remain at 5.25% until the end of 2024 and not until mid-2024 as investors expect. That said, a mild recession in the interim may mean that rates will fall to 3% in 2025 rather than the 4.25-4.5% assumed by markets,” analyzes Paul Dales, strategist at Capital Economics.
For the economist, the big news is that the central bank has decided to stress even more that it does not believe it will be lowering interest rates for a long time. The phrase that policy will be “sufficiently tight for long enough” has been repeated, but it has been strengthened by adding the phrase: “The MPC’s forecasts indicate that monetary policy is likely to have to be tight for an extended period of time,” explains Dales. The Committee has not used the term “extended period” before, so there is no precedent for its meaning. Governor Andrew Bailey also said in a separate statement released today that “it is too early to think about rate cuts.”
In writing with the decision, BoE officials acknowledge that underlying inflationary pressures remain “elevated” in advanced economies and that news from the Middle East may have an impact on energy prices. However, they also admit, since the BoE’s last meeting, long-term government bond yields have risen, which has supported the tightening of financial conditions pursued by the central bank without the need to raise rates. In contrast, they point out, UK growth is at a complete standstill.
“UK Gross Domestic Product (GDP) is expected to have been flat in Q3 2023, weaker than forecast in the August report. Some business surveys point to a slight contraction in output in the fourth quarter, but others are less pessimistic. GDP is expected to grow by 0.1% in the fourth quarter, also weaker than previously forecast,” write the BoE MPC members. These forecasts stem from a projection of rates at 5.25% through the third quarter of 2024 and a subsequent gradual decline to 4.25% by the end of 2026, a lower profile than that underpinning the August projections.
UK inflation
In the sandy terrain of inflation, the latest consumer price index (CPI) data showed an increase of 6.7% year-on-year, the same as in August and still well above the central bank’s 2% target and the rate recorded in both the US and the eurozone (3.7% and 2.9% respectively in October). While in August the figure surprised positively, this time the rebound in oil prices prevented it. Core inflation – which excludes volatile food and energy prices – fell less than expected, from 6.2% to 6.1%, and services inflation, closely watched by the BoE, unexpectedly accelerated to 6.9% from 6.8%.
“CPI inflation remains well above the 2% target, but is expected to continue to fall sharply, to 4.75% in Q4 2023, 4.5% in Q1 2024 and 3.75% in Q2 2024. This decline is expected to be driven by lower energy, core goods and food price inflation and, beyond January, some fall in services inflation,” the BoE notes in its forecast.
“In the latest most likely, or modal, MPC projection conditional on the implied market path for the bank rate, CPI inflation returns to the 2% target by the end of 2025. It then falls below the target thereafter as an increasing degree of economic deterioration idle capacity reduces domestic inflationary pressures,” the officials add. They also state that “second-round effects on domestic prices and wages will take longer to fade than to emerge” and that the average CPI inflation projection is 2.2% and 1.9% over the two- and three-year horizons, respectively.
As for the labor market, a source of inflationary pressure to the extent that labor has been in short supply for reasons ranging from Brexit to the pressing number of long-term sick leaves following covid, the Committee admits that the latest statistical changes in employment data do not help, but they reinforce its thesis that, “in a context of subdued economic activity, employment growth is likely to have subdued during the second half of 2023.”
“Falling vacancies and surveys indicating a decline in hiring difficulties also point to a loosening labor market. BoE agent contacts have also reported an easing of hiring restrictions, although persistent skills shortages persist in some sectors. Wage growth has remained elevated in a number of indicators, although the recent increase in the annual growth rate of regular average weekly earnings in the private sector has not been evident in other series. There remains uncertainty about the near-term wage trajectory, but wage growth is nonetheless expected to decline in the coming quarters from these elevated levels,” they complete from the MPC.