BOE’s bleak UK outlook lifts bets on sharp rate cuts in 2024

The financial markets may disagree with Bank of England Governor Andrew Bailey’s claim that it is too early to consider rate cuts.

The BOE is expected to cut the benchmark rate by up to three quarter points, or 4.5%, before the end of 2024.

Investors’ bets are in stark contrast to the message Bailey reiterated seven times and at a press conference following the decision.

The governor wants the markets to be prepared for the BOE to continue its strategy of higher rates, longer to control inflation. Inflation is still more than three times the BOE target of 2%. Huw Pill, the BOE’s Chief Economist, has nicknamed the profile of the flat-topped landmark near Cape Town “Table Mountain”.

Investors are increasingly expecting rates to be cut in the second half 2024, as they fear that the UK economy may break under the pressure of rates at the highest level for 15 years. The UK economy is in a state of crisis, with unemployment at a high level, housing prices nearing a standstill and wages rising near a record.

Oliver Blackbourn is a portfolio manager for Janus Henderson investor.

According to swaps based on policy meeting dates, the markets have made their judgments after the BOE’s latest decision. They fully priced in two quarter-point cuts starting in August, and opened the possibility of a third in 2024. This compares to only one reduction that was priced-in just two weeks earlier.

New economic forecasts from the BOE assume a reduction. When they released their latest forecasts, officials included a market expectation of a rate cut.

The UK led the global bond rally, as markets re-priced. At one point, the yield on gilts of 10 years fell by 18 basis points and reached a new low.

The BOE is now in line with the US Federal Reserve, and the European Central Bank. Henry Cook, senior economics at MUFG said that the global tightening of monetary policy cycle is over.

In conjunction with its rate decision, the BOE lowered growth expectations. The BOE has downgraded growth to zero in 2024 from 0.5% previously projected. In 2025, a paltry 0.25% increase is projected.

In 2024, the post-tax household income will only increase by 0.25%. In the face of this bleak backdrop, Rishi Sunak has to call elections by January 2025.

Bailey admitted that the BOE is largely responsible for the economic downturn, and not the energy or food price increases. In a Thursday press conference, he said that the forecast “reflects the fact the policy is restrictive and we can see the evidence that supports that.” The central bank estimates that only half the impact of rate increases has reached the economy.

Bailey credited the drop in inflation so far to his efforts. He wrote in the Evening Standard that consumer price growth, which peaked at 11,1% last year, is now 6,7% and could drop below 5% by October figures released later this month. He told reporters that inflation was still well above the 2% target and there was “absolutely nothing to complacent about”.

The BOE’s current debate is whether or not to raise interest rates. Bailey stated that there has been no discussion about a rate cut this month due to the lingering risks of inflation.

Officials have also reduced their estimate of the supply capacity for the economy. This is due to the shrinking workforce, which has led to the rise in wages. Nomura economics said that the judgment was one of the most significant in the forecast. It helps explain why nine members of the Monetary Policy Committee haven’t yet embraced the market view on rate cuts.

The MPC, voting 6-3 in favor of no change for this month, had three dissenters who wanted an increase to 5%. Officials have reaffirmed their forecasts to emphasize that there will not be any easing of interest rates until inflation reaches the target.

The minutes stated that “Policy will likely need to be restrictive over an extended period.” Nomura stated that the new language is intended to “push against market pricing and early cuts.”

Bailey also pushed back on that interpretation. In an interview, he stated: “If the market believes that what we published today indicates that we lean towards more cuts, then I am afraid that I will lean away from that.”