Bank of England in the City of London after data showed the British economy fell into recession at the end of 2023.
Yui Mok | Pa images | Getty Images
LONDON – The Bank of England is expected to keep interest rates unchanged at 5.25% on Thursday, but economists are divided over when the first cut will occur.
Headline inflation fell more than expected to an annualized 3.4% in February, hitting its lowest level since September 2021, data showed on Wednesday. The central bank expects the consumer price index to return to its 2% target in the second quarter as the cap on household electricity prices falls again in April.
The sharper-than-expected fall in both core and headline indicators was welcome news for policymakers ahead of this week’s interest rate decision, although the Monetary Policy Committee has so far been reluctant to give clear guidance on the timing of the first rate cut. .
The UK economy fell into a technical recession in the last quarter of 2023 and suffered two years of stagnation after a huge shock to gas supplies following Russia’s invasion of Ukraine. Berenberg senior economist Callum Pickering said the Bank was likely looking to ease policy soon to support a strong economic recovery.
Pickering suggested that in light of Wednesday’s inflation data, the MPC could “give its stamp of approval to current market expectations for a first cut in June”, which could then be embedded in updated economic forecasts for May.
“Further soft adjustments at the March meeting would follow the trend of recent meetings of policymakers gradually losing their hawkish bias and instead turning to the question of when to cut rates,” he added.
At the February meeting, two of the nine MPC directors still voted to raise the Bank’s prime rate by a further 25 basis points to 5.5%, while another voted to cut it by 25 basis points. Pickering suggested that both hawks might choose to hold rates this week or that another member might argue for a rate cut, and noted that “early actions by dissenters often signal upcoming turning points” in the Bank’s 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 expects five 25 basis point cuts to bring its benchmark rate to 4% by the end of the year, followed by another 50 basis point cut to 3.5% at the start of 2025. This will still mean that interest rates will exceed inflation. at least in the next two years.
“The risks associated with our call involve smaller cuts in 2025 – especially if the economic recovery gains momentum and policymakers begin to worry that strong growth could again increase wage pressure in already tight labor markets,” Pickering added.
We are going the right way, but not “home and dry”
The key point for the MPC was the tight UK labor market, which it feared could exacerbate inflation risks in the economy.
January data released last week showed a weaker picture across all labor market indicators, with wage growth slowing, unemployment rising and job openings falling for the 20th straight month.
Victoria Clarke, chief UK economist at Santander CIB, said that after weaker labor market data last week, Wednesday’s inflation data provided further evidence that built-in risks have eased and that inflation is on track for a sustained return to target. indicator.
“However, services inflation is broadly in line with the Bank of England’s forecast since February and remains elevated. an increase in the National Living Wage of almost 10%, and many firms have already announced, and some have already implemented, increases in living wages,” Clarke said in an email.
“The Bank of England needs data on how much of an impact this will have on wage setting, as well as precise information on how much money will be committed to setting prices in the coming months.”
Santander believes the Bank may decide it has seen enough data to cut rates in June, but Clark argues an August rate cut would be “more sensible” given the “monthly noise” in labor market figures.
That view was echoed by Moody’s Analytics on Wednesday, with senior economist David Muir also suggesting the MPC would need more evidence to make sure inflation pressures were contained.
“In particular, it is necessary to further slow down inflation in the service sector and wage growth. We expect the necessary easing to occur in the first half of the year, allowing for interest rate cuts to be announced in August. the timing and extent of rate cuts this year,” Muir added.