Bank of England set to hold rates despite improving inflation backdrop

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The Bank of England is likely to acknowledge this week that it is seeing unexpectedly rapid progress in getting inflation down, analysts said, but the central bank is not expected to begin cutting interest rates yet.

The BoE’s Monetary Policy Committee is widely anticipated to hold rates at 5.25 per cent for a fourth straight month at its first meeting of 2024, after an aggressive campaign of 14 rate rises aimed at quashing inflation. 

The policy announcement, due on Thursday, will be accompanied by new forecasts that are expected to show sharp declines in UK inflation in the coming months.

Receding price growth around the world has stoked expectations that central banks including the Federal Reserve and European Central Bank will embark on rate reductions this year. 

Allan Monks, UK economist at JPMorgan, said the BoE would need to make a “dovish pivot” that acknowledges the possibility of easier monetary policy this summer while not encouraging expectations of cuts in the spring.

“The BoE’s updated narrative is likely to be that clear progress is being made on inflation, but that it is too early to declare victory,” he added.

Consumer price inflation in the UK ticked up to 4 per cent in December from 3.9 per cent the month before, but that left the rate far below the levels exceeding 10 per cent that it reached a year earlier.

Although the UK lagged peer countries in getting inflation down, it now has a headline rate slightly lower than that of France, where inflation stood at 4.1 per cent on the EU Commission’s HICP measure in December.

The UK’s inflation figure remains above the US and Germany’s December figures rate of 3.4 per cent and 3.8 per cent respectively. 

At the BoE’s meeting, progress on inflation may prompt some or all of the three MPC members who have been calling for further interest rate increases to drop their demands, economists said.

Investors will be watching to see if Swati Dhingra, the most dovish member of the committee, calls for immediate reductions in borrowing costs. 

Central bankers are treading a fine line: if they cut interest rates too soon, they risk a resurgence of price pressures, but wait too long and they could do unnecessary damage to the economy and labour market.

Official data suggests UK economic growth has stagnated since the summer. In November, GDP fell month-on-month by 0.3 per cent after increasing by the same figure the previous month.

Meanwhile, the Office for National Statistics is not publishing its usual jobs data at present because of problems with the survey underpinning it. Other data sources suggest unemployment remains low while hiring has weakened.

The BoE is likely to cut its inflation forecast and upgrade its growth forecast next week largely because lower wholesale gas prices will soon bring down energy bills.

Analysts expect inflation as measured by the Consumer Prices Index to retreat to about 2 per cent in the second quarter of the year — well below levels of around 3.6 per cent previously expected by the Bank. 

BoE governor Andrew Bailey in December warned there was “some way to go” as the MPC predicted inflation would not return to its 2 per cent target until 2025.

The BoE has made clear it will not relax monetary policy when the UK still has high wage growth and services price inflation. Services price inflation in December fell to 6.4 per cent, while regular pay growth slipped to 6.6 per cent in November, still high readings despite the declining trend.

But some analysts think Bailey now needs to at least open the door to a change of tack later this year — as Fed chair Jay Powell and European Central Bank president Christine Lagarde have already done.

The Fed is also due to meet this week, and like the BoE is widely expected to keep rates unchanged. Last week, Lagarde pointed towards a rate cut this summer and said the “disinflation process is at work” in the eurozone.

A first step in a similar direction would be for the BoE to soften its past language that further tightening of monetary policy “would be required” if there was evidence of more persistent inflationary pressures.

Paul Dales, of Capital Economics, said he expected the bank to “throw in the towel” on the notion that it was prepared to lift interest rates further. He expects the first cut to come in June.

Investors will also be watching to see if the BoE tweaks language declaring that monetary policy will probably “need to be restrictive for an extended period of time”.

The BoE will also include in its February monetary policy report an annual assessment of the supply side of the economy, revealing its view on the UK economy’s capacity to grow over time without fuelling inflation. 

Jens Larsen, of the consultancy Eurasia Group, said recent economic news was consistent with “very weak growth and a relatively rapid decline of inflationary pressures”.

But given continued inflation risks, including from conflict in the Middle East, he expected the BoE to acknowledge progress while pushing back on the notion it was about to start aggressively slashing interest rates.

Bailey, Larsen added, faced a “very, very difficult balancing act”.