Bank of England lays ground for summer cuts

The Bank of England’s Monetary Policy Committee (MPC) has voted to maintain rates at 5.25 per cent for a sixth successive time.

Seven committee members voted to hold rates at 5.25 per cent, while two favoured a 0.25 percentage point cut. In a more dovish statement issued after the decision, rate-setters said that the committee would “keep under review for how long Bank Rate should be maintained at its current level”, adding that "the committee will consider forthcoming data releases and how these inform the assessment that the risks from inflation persistence are receding". 

New forecasts released alongside the announcement showed that the Bank expects inflation to drop to 1.9 per cent in two years, and 1.6 per cent in three. In the last forecasting round in February, the BoE projected inflation of 2.3 per cent in two years, and 1.9 per cent in three. Today’s lower inflation forecasts imply that the BoE thinks the economic outlook is more supportive of rate cuts. 

According to the latest forecasts, economic growth should pick up over the forecast period as the impacts of higher interest rates start to recede. The MPC forecasts four-quarter real GDP growth of 0.9 per cent in a year and 1.2 per cent in two. It expects unemployment to rise to 4.6 per cent by this time next year, and 4.8 per cent in the second quarter of 2026.

In the US, Federal Reserve rate-setters also held interest rates at 5.25-5.5 per cent when it met last week. Following a raft of resilient US data releases, Fed chair Jerome Powell said it would take longer to gain the "greater confidence" needed to cut rates. 

Though Powell dampened speculation about the need for further US rate hikes, he did warn that higher rates would “need more time to do their job”. As a result, many analysts expect that the Bank of England will be in a position to loosen policy before the Fed this year.

The case for a longer hold

However, not all MPC members were convinced about the need for rate cuts – as the chart below shows. Last month, the BoE’s chief economist Huw Pill warned there were "greater risks associated with easing too early should inflation persist rather than easing too late should inflation abate”. He voted to hold rates today. Some rate-setters remain concerned about inflation becoming embedded in expectations and feeding into higher wage and pay demands.

UK wage growth remains high at almost 6 per cent, and services inflation is running similarly hot. Megan Greene, another MPC member, recently argued inflation would stay elevated in the UK thanks to the “double whammy of a very tight labour market and a trade shock from energy prices”. As a result, she thought cuts should "still be a way off”, and also voted to hold interest rates today. 

Some economists also question the practicalities of loosening policy before the Fed. All else being equal, high US interest rates coupled with UK rate cuts would weaken the pound. This would increase the cost of imports (especially commodities priced in dollars), an unhelpful headwind when rate-setters are worried about inflationary pressures.

The case for summer cuts

Yet there is no denying that the US and the UK face very different economic backdrops. After the latest US rate-setting meeting, Powell said that “the difference between the United States and other countries that are now considering rate cuts is that they’re just not having the kind of growth we’re having”, and the figures bear this out. 

The OECD expects the US economy to grow at 2.6 per cent this year, against 0.7 per cent for the Euro area and 0.4 per cent for the UK. BoE governor Andrew Bailey has previously stressed inflation in the US was more “demand-led” than in the UK.

The chart below shows that though US inflation retreated quickly, it has been a difficult final mile back to the inflation target. The UK is expected to experience a far smoother journey: forecasts suggest that the headline rate of CPI will fall very close to the 2 per cent target when new data is released at the end of May. Last month, BoE deputy governor Dave Ramsden said that the UK is no longer an inflation outlier and the balance of risks was ‘tilted to the downside’. He voted for a cut in today’s meeting. 

Beat the Fed to the punch

This means the BoE could cut interest rates before the Fed, and may even move next month. Between now and the June meeting, two sets of wage and inflation data will be released, which should show inflation returning to the 2 per cent target. 

Traders seem less sure that the BoE will strike out on its own. Before today’s meeting, markets had priced in 0.41 percentage points of cuts this year – only slightly more than for the Fed. Before the meeting, markets placed just a 45 per cent chance of a cut in June.

According to the CME FedWatch tool, traders expect a first US rate cut in September, with a less than 10 per cent chance of a June cut.