- Rates held steady since August
- Questions turn to when the MPC will start cutting the base rate
Bank of England rate setters voted again to hold interest rates at 5.25 per cent, leaving the UK base rate unchanged since August. Economists now see little prospect of further rate hikes, but when the Monetary Policy Committee (MPC) will move to cut interest rates remains a far more contentious question.
Today’s decision was finely balanced. Six members of the MPC voted to hold rates at 5.25 per cent, while three favoured an additional 0.25 percentage point hike.
Following the decision, Bank of England officials released a statement stressing that “given the significant increase in Bank Rate since the start of this tightening cycle, the current monetary policy stance is restrictive”. Yet they dashed hopes of imminent cuts, stating that “the Committee continues to judge that monetary policy is likely to need to be restrictive for an extended period of time”.
This hawkish guidance stood in contrast to the more dovish tone struck by US policymakers earlier in the week. On Wednesday night, the Federal Reserve voted to hold rates constant at 5.25-5.5 per cent, and Chair Jerome Powell said that “our policy rate is likely at or near its peak for this tightening cycle”. The announcement was also accompanied by new economic projections, which suggest that US rates will be cut to 4.5-4.75 per cent by the end of 2024.
How far have this year’s rate hikes fed through?
December’s BoE monetary policy meeting came after two crucial UK data releases. On Tuesday, Office for National Statistics (ONS) data revealed that annual regular earnings growth had fallen from 8 per cent to 7.3 per cent. This was a bigger drop than analysts had expected, and the slowdown provided some welcome evidence of easing wage pressures.
Yet the December figures remain one of the highest growth rates since records began. As CPI inflation in the UK has fallen to 4.6 per cent, wages are still rising significantly faster than prices. The ONS calculates that once inflation is taken into account, real regular pay grew at 1.4 per cent over the period.
More hawkish members of MPC have continued to voice concerns about the tightness of the labour market and the potential for high wage demands to fuel inflation persistence. Economists estimate that wage growth needs to cool to around 3 per cent for inflation to return to its 2 per cent target.
Yet policymakers are also acutely aware that it takes around 18 months for interest rates to feed through to the economy and the pressure of previous interest rate hikes will continue to build throughout 2024. Economists at KPMG calculate that 1.5mn fixed-rate mortgages are due to expire next year, and expect higher mortgage costs to subdue consumer spending next year.
On Wednesday, ONS data showed that monthly GDP fell by 0.3 per cent in October, as bad weather and industrial action dampened activity. In the three months to October, the UK economy recorded no growth at all.
Following the release, Lindsay James, investment strategist at Quilter Investors, said the BoE had done "a good job of not tipping the UK into recession, but interest rates are biting and further contraction cannot be ruled out”. She added that “calls for rate cuts are likely to grow stronger should this sort of economic data persist”.
When will we see rate cuts?
Markets and economists expect rate cuts at some point in 2024. The big question is whether they will come towards the middle of the year or the end.
Before today's meeting, market pricing indicated that the BoE would start cutting rates around June – but only modestly. Traders expected interest rates to fall to 4.5 per cent by the end of next year, representing 0.75 percentage points of cuts. Economists at Pantheon Macroeconomics think that wage growth will slow over the winter, allowing the BoE to loosen policy from May onwards. They forecast cuts at alternate meetings, taking interest rates to 4.5 per cent by the end of 2024.
But some economists expect rate cuts to materialise far later. Following Wednesday’s disappointing GDP figures, Paul Dales, chief UK economist at Capital Economics, warned that wage growth might not fall as fast as anticipated, forcing the Bank to hold off on rate cuts until late 2024.
There is also the possibility that UK rate cuts go deeper than markets currently expect. Mike Riddell, head of Macro Unconstrained at Allianz Global Investors, thinks that as previous interest hikes start to bite, the hit to UK growth would be "far greater than most expect”. A sharp slowdown means inflationary pressure could quickly subside, providing more scope for cuts.
As today’s voting outcome shows, even rate setters are split on which scenario will ultimately play out.
