The Bank of England has indicated that it will cut rates if the inflation rate remains low this summer, even though it is keeping borrowing costs at their highest level in 16 years of 5.25 percent.
Andrew Bailey, Governor, said on Thursday that a cut in rates during the next Monetary Policy Committee meeting, scheduled for June, was neither “ruled-out” nor “a fait accompli”.
He added that it is likely we will have to lower bank rates in the next quarters. . . The BoE is expected to cut rates by 0.25 percentage points in December.
James Smith, an economist at ING said that the BoE message was “distinctly more positive”, and suggested it “was getting very close to [its first] rate cut” even though they had not been clear in June.
The MPC voted seven to two in favor of keeping the benchmark rate at 5,25 percent, and vice governor Sir Dave Ramsden joined external member Swatidhingra to vote for an immediate reduction.
Reuters polled economists who predicted that only one vote would be cast for a reduction, which is in line with MPC’s March meeting.
Bailey stated that there were “encouraging” news on inflation, and that it will fall close to the Bank of England’s target of 2 per cent in the coming months. However, he cautioned that the BoE is not yet ready for action.
He said, “We must see more proof that the inflation rate will remain low before we cut interest rates.” “I am optimistic that things are going in the right directions.”
He said the MPC expects inflationary pressures underlying to decline “slightly quicker” than it had previously expected.
The MPC has adopted a new phrase that states it will “consider forthcoming data” (which refers to the inflation and employment figures) in order to determine whether “the risk of inflation persisting is receding”.
The MPC will meet on June 20.
The timing of this first BoE rate reduction in four years is gaining political significance ahead of the expected general election later this year. Rishi Sunak, the Prime Minister of the UK, is trying to convince voters that Britain has overcome the crisis.
European central banks will also diverge from US Federal Reserve in the next few months by lowering interest rates, betting on a less persistent inflation than the US where the demand is higher.
Bailey sought to counter market perceptions of the BoE delaying its first rate reduction if the US were slower in cutting borrowing costs.
He said that there is no law stating that the Fed must move first.
The BoE, however, is cautious about jumping to conclusions too quickly after a hard-fought battle to reduce price pressures to the current rate of 3.2 percent from double-digit levels.
Investors have a probability of around 45 percent that the rate will be cut in June. This is about the same as it was before Thursday’s announcement.
After the decision, yields on two-year gilts that are sensitive to interest rates fell 0.05 percentage points and reached 4.27 percent. The FTSE 100 index rose 0.3 percent on the hope of rate reductions this summer.
The minutes of the meeting this week also showed that there are still divisions in the MPC. They noted a “range” of opinions on how long inflation will likely last and what evidence is required to justify a rate reduction.
Ramsden and Dhingra said that the MPC meeting, inflation was “firmly on a downward trajectory”, and rates “needed now to become less restrictive”.
The MPC stated that the official job statistics are “considerably uncertain” and make it difficult to assess the state of the labour market.
In its forecasts, published on Thursday, the bank predicted that the inflation rate will fall to 2 percent in the second-quarter before rising to 2.6% in the next quarter.
The forecast was that inflation would fall to 1,9% in two years and to 1,6% in 2027.
These forecasts of inflation below target indicate that future interest rates may be lower than the markets expect.
The bank forecasts a 0.4% growth rate for the first quarter and a 0.2% growth rate for the second.
The overall picture is still weak. GDP growth will only be 0.5 per cent for this year. This will then accelerate to 1 per cent by 2025, and to 1.25 per cent by 2026.