The Bank of England in London, after figures showed the British economy sliding into recession at the end of 2023.
Yui Mok | Photo ba | Getty Images
LONDON – The Bank of England is widely expected to keep interest rates unchanged at 5.25% on Thursday, but economists are divided on when the first cut will be.
Data on Wednesday showed headline inflation fell more than expected to an annual 3.4% in February, reaching its lowest level since September 2021. The central bank expects the CPI to return to its 2% target in the second quarter, as price caps are lowered. Home energy back in April.
The larger-than-expected decline in both headline and core numbers was welcome news for policymakers ahead of this week's interest rate decision, although the Monetary Policy Committee has so far been reluctant to provide firm guidance on the timing of the first cut.
The UK economy slid into a technical recession in the last quarter of 2023 and suffered two years of recession, after a huge gas supply shock following the Russian invasion of Ukraine. Calum Pickering, chief economist at Berenberg, said the bank was likely to hope to ease policy soon in order to support the buoyant economic recovery.
Pickering suggested that in light of Wednesday's inflation data, the MPC might “give a signal to current market expectations for a first cut in June,” which it could then reinforce in the updated May economic outlook.
He added: “More cautious adjustment at the March meeting would be in line with the trend in recent meetings of policymakers who have gradually lost their hawkish bias and are instead shifting towards the question of when to cut interest rates.”
At the February meeting, two of the nine decision-makers on the Monetary Policy Committee voted in favor of raising the bank's key interest rate by another 25 basis points to 5.5%, while another voted in favor of a 25 basis point reduction. Pickering suggested that both hawks might choose to hold rates this week, or another member might favor a cut, and noted that “early moves by dissenters often signal upcoming turning points” in bank rate cycles.
Berenberg expects headline annual inflation to fall to 2% in the spring and remain close to that level for the rest of the year. The bank is expected to cut its key interest rate by 25 basis points to 4% by the end of the year, before further cuts of 50 basis points to 3.5% in early 2025. This still means interest rates will outpace inflation. For at least the next two years.
“The risks to our call lean toward smaller cuts in 2025 – especially if the economic recovery builds momentum and policymakers begin to worry that strong growth could inflame wage pressures in already tight labor markets,” Pickering added.
Heading in the right direction, but not “go home and dry out”
The MPC's main focus has been the UK's tight labor market, which it fears will entrench inflationary risks in the economy.
January data published last week showed a weaker picture across all labor market metrics, with wage growth slowing, unemployment rising and job opening numbers falling for the 20th month in a row.
Victoria Clarke, chief UK economist at Santander CIB, said that after last week's weak labor market numbers, Wednesday's inflation reading was another indication that underlying risks have declined and inflation is on track to a sustainable return to target.
“However, services inflation has largely tracked the Bank of England's forecast since February, and remains high. As such, we do not expect the BoE to conclude that it is 'settled and dry', especially as April represents a critical point for UK inflation,” he said. “With an approximately 10% increase in the National Living Wage, many companies have already announced, and some have implemented, wage increases tied to the Living Wage,” Clark said via email.
“The Bank of England needs data on how broad the uplift in wage setting this is, and reliable information on how much is passed on to price setting over the following months.”
Santander believes the bank may decide it has enough data to cut interest rates in June, but Clark said a rate cut in August would be “more prudent” given the “month-to-month noise” in labor market numbers.
This view was echoed by Moody's Analytics on Wednesday, with chief economist David Muir also noting that the Monetary Policy Committee will need more evidence to be satisfied that inflationary pressures are contained.
“In particular, services inflation and wage growth need to moderate further. We expect this necessary easing to unfold over the first half of the year, allowing interest rate cuts to be announced in August. However, uncertainty is high around the market,” Muir added. The timing and extent of interest rate cuts this year.”
