Britain’s central bank is expected to maintain its current interest rates, which are the highest they have been in almost 16 years. However, investors are on the lookout for any indications of potential rate cuts in the future as inflation is projected to reach the Bank of England’s 2% target sooner than expected.
Since the Bank of England’s last forecasts were published on November 2, energy prices have significantly decreased. This shift has led many economists to believe that inflation, which stood at 4% in December, could return to the target level as early as April, a significant deviation from the Bank of England’s estimate of late 2025.
The central bank had previously expressed concerns about a slow decline in inflation, which had reached a peak of 11.1% in October 2022, its highest level in over four decades. Consequently, the Bank of England warned last year that interest rates would need to remain high for an extended period and might even need to increase further.
In December, three of the nine policymakers voted in favor of raising rates from 5.25% to 5.5%, as the stagnant economy failed to dampen rapid wage growth, a key factor contributing to medium-term inflation trends.
However, in the upcoming rate decision, economists surveyed by Reuters expect only one policymaker to vote for a rate hike, while some believe another policymaker may suggest a rate cut for the first time since March 2020.
Mohit Kumar, chief European economist at U.S. investment bank Jefferies, anticipates that the Bank of England’s outlook on inflation will reflect a modest victory, as the path toward lower inflation seems satisfactory. However, Kumar also cautions that it might be premature to declare complete success.
Governor Andrew Bailey is scheduled to hold a press conference following the rate decision, during which he will have various options to convey a more relaxed policy stance.
According to the Reuters poll conducted last month, economists predict that the Bank of England will commence rate cuts in the second quarter of this year. Financial markets have already factored in a quarter-point rate reduction in May, with rates potentially reaching 4.25% by year-end.
In contrast to the Bank of England, officials at the European Central Bank openly discussed the possibility of rate cuts last month.
Late on Wednesday, Federal Reserve Chair Jerome Powell announced the likelihood of rate cuts in the U.S later this year. However, this would only occur if officials gain greater confidence that inflation is sustainably approaching the 2% target.
Recent data reveals that the British economy has experienced sluggish growth, with the risk of falling into a mild technical recession. The International Monetary Fund’s latest forecast projects that the UK economy will only grow by 0.6% this year, making it the second weakest among the Group of Seven advanced economies after Germany, which also faced significant challenges due to a surge in gas prices following Russia’s invasion of Ukraine in February 2022.
The economic backdrop poses challenges for Prime Minister Rishi Sunak, who is required to hold a national election within the next year. A potential factor influencing the Bank of England’s caution in signaling future policy loosening is the possibility of further tax cuts at Finance Minister Jeremy Hunt’s budget presentation on March 6.
Another concern of central bank policymakers is the potential persistence of wage inflation, which may not decrease to the anticipated level of around 3%. Annual wage growth, excluding bonuses, reached 6.6% in the three months leading up to the end of November. Furthermore, many large employers are planning to offer annual pay increases in the range of 5% this year.
Additionally, ongoing conflicts in the Middle East, which have resulted in higher freight costs due to shipping attacks in the Red Sea, may complicate the Bank of England’s ability to implement rate cuts.
Karen Ward, chief market strategist for Europe, the Middle East, and Africa at J.P. Morgan Asset Management, suggests that the Bank of England may view any drop in inflation below 2% as temporary and insufficient grounds for a rate cut. She emphasizes the importance of the Bank clearly stating that it will not place excessive weight on temporary low inflation, just as it did not overemphasize transitory high inflation.
In conclusion, the Bank of England is expected to maintain its current interest rates, but investors are eager for any clues regarding imminent rate cuts. The continued decline in energy prices has led economists to project that inflation will meet the Bank of England’s 2% target as early as April. The central bank’s decision will be influenced by factors such as the sluggish economic growth, ongoing wage inflation, and potential conflicts in the Middle East. Governor Andrew Bailey’s press conference following the rate decision may provide further insight into the bank’s policy stance.
