Bank of England holds rates but opens door to cuts

The Bank of England (BoE) kept interest rates at a nearly 16-year high on Thursday but opened up the possibility of cutting them as inflation falls and one of its policymakers cast a first vote for a reduction in borrowing costs since 2020.

BoE governor Andrew Bailey said inflation was “moving in the right direction” after he and his colleagues ditched a previous warning that rates could rise again and said borrowing costs would be kept “under review”.

It was the first time since 2008 that the monetary policy committee had voted for both rate cuts and hikes at the same meeting. Six members voted to keep rates at 5.25%, Jonathan Haskel and Catherine Mann opted for a 0.25 percentagepoint hike and Swati Dhingra backed a cut of the same size.

Economists polled by Reuters mostly expected only one policymaker to vote for a rate rise and for the others to vote to keep rates on hold.

The pound erased earlier losses and investors trimmed bets on the extent of cuts, but still saw four reductions in 2024.

Bailey said it was too soon to declare victory and getting inflation down to its 2% target would not be “job done” because of the risk it could pick back up. But he said there was a shift in the BoE’s thinking.

“For me, the key question has moved from ‘how restrictive do we need to be?’ to ‘how long do we need to maintain this position for?’” he told reporters.

The BoE dropped its warning that further tightening would be required if more persistent inflation pressure emerged.

It also pointed out that its “extended period” for keeping policy at restrictive levels began in November a message that BoE officials think a chunk of this period has already elapsed.

The US Federal Reserve (Fed) and European Central Bank (ECB) have been more explicit that rate cuts are on the agenda.

Late on Wednesday the Fed said rates had peaked and would move lower later this year.

Hetal Mehta, head of economic research at St. James’s Place, said the BoE remains worried about underlying inflation pressures in Britain.

“We still think the BoE is likely to be behind”the ECB and Fed in cutting rates, she said.

The BoE reiterated that policy would need to stay “restrictive for sufficiently long”.

Despite chopping its inflation forecast for the coming months, considerably higher wage growth set Britain apart from its peers in driving longer-term inflation pressure. On the implications for inflation from the turmoil in the Middle East, it said: “There might be potential upside risks from geopolitics.”

Consumer price inflation now looks likely to return to 2% in the second quarter of 2024, albeit briefly. In November, the BoE said that would not happen until the end of 2025.

But the medium-term forecast based on a much lower market path for interest rates than in November showed inflation would rise back above 2% in the third quarter of 2024 and not return to target until late 2026, a year later than the BoE had forecast in November.

That represented a message to markets that their bets on rate cuts might be overdone.

The BoE stuck to its view that Britain’s economy will struggle to generate much economic growth in the coming years, despite a modest upgrade to the annual growth projections.

In a small boost for chancellor of the exchequer Jeremy Hunt, the BoE judged that the tax cuts he announced in November

ahead of a national election expected this year would boost economic output slightly.

But the central bank largely kept its forecast for weak household income growth after tax and inflation. Households’ living standards have fallen over the past two years due to high inflation, contributing to the electoral challenge facing Prime Minister Rishi Sunak.