BOE Embraces Caution After Year That Failed to Deliver on Rates

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(Bloomberg) — The Bank of England entered the year with investors anticipating six interest rate cuts, a surprise easing that promised to breathe life into the U.K. economy. It will end 2024 with borrowing costs a full percentage point higher than expected 12 months ago.

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The Bank of England is expected to leave interest rates unchanged at 4.75% at its meeting on Thursday and maintain its guidance that “a gradual approach to removing policy constraints remains appropriate.” While Bank of England Governor Andrew Bailey has said four cuts are likely over the course of 2025, markets – perhaps influenced by their aggressive bets a year ago – are pricing in just three cuts, starting in February.

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The decision on December 19, which is expected to be a wait-and-see meeting, will conclude a year very different from the one traders and some economists expected in January when Britain was emerging from a mild recession with interest rates at 16 percentage points. -High year.

At the time, markets were expecting cuts of six-quarter percentage points to 3.75% in 2024 – a path endorsed by Goldman Sachs economist Sven-Jari Steen. Instead, the Bank of England made just two, in August and November, as officials expressed concern that too rapid easing in a tight labor market threatened to reignite inflation.

Their reluctance to lift the brakes has left the Bank of England lagging behind the easing cycles of its counterparts in the US and the euro zone, and made the pound the best-performing G10 currency this year.

The result is that monetary policy has focused more strongly on inflation, which has fallen more quickly than the Bank of England forecasts and is now just above the 2% target. It’s a sign of success, Bailey said.

But businesses, consumers and homeowners accused the bank of causing unnecessary pain. The Bank of England was even under political pressure to cut interest rates before the general election in July, with the then Conservative Chancellor of the Exchequer, Jeremy Hunt, repeatedly bringing up the prospect of cheaper money as he sought to create a feel-good factor in the economy. Economists and former officials have criticized his intervention for infringing on the independence of the central bank.

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Prices at the beginning of the year were greatly influenced by developments in the United States. Financial markets are betting that the Bank of England and the Federal Reserve will deliver one and a half points of cuts. Expectations quickly changed after it became clear that the US economy was performing much better than expected, and that the Bank of England was not convinced that it had won the battle to tame underlying price pressures in the services sector.

The Monetary Policy Committee once again heads into the new year with little clarity on the outlook and the economy is at a crossroads. In 2024, the UK elections shed light on the outlook. Now, the next US President, Donald Trump, is threatening a global trade war, while the first budget of the Labor government in October left, at the local level, unanswered questions.

Business and consumer sentiment has weakened further since the Budget, when Treasurer Rachel Reeves announced a £26 billion ($32.9 billion) tax on employers. At the same time, growth stalled and inflation showed signs of rising. That complicates policy for the bank, which has “expressed uncertainty about the passage of fiscal measures,” said Sonali Bonhani, an economist at Bank of America in the UK.

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Depending on how businesses respond to a payroll tax increase and another large hike in the minimum wage, inflation may be more stable or growth may be weaker. Labor has also borrowed heavily to boost public investment, which both the Office for Budget Responsibility and the Bank of England judge will push up rates.

“The bulk of the MPC seems content to simply monitor near-term developments and meet again in February, perhaps with more conviction about the future path,” said Bruna Skarica, chief UK economist at Morgan Stanley.

This week’s deluge of data may help clear things up. Consumer price figures on Wednesday are expected to show inflation rose 0.3 percentage point to 2.6% in November. This is higher than the 2.4% forecast by the Bank of England, which expects price growth to accelerate due to energy prices before returning towards target. Economists believe that services inflation will remain high at 5.1%.

Regular wage growth, another measure of underlying pressures, is expected to rise slightly to 5% when jobs data is published on Tuesday. The Bank of England agrees that wage growth of more than 3% or so is not compatible with an inflation rate of 2%.

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Any sign of declining hiring could persuade the MPC’s newest member Alan Taylor to join fellow outsider Swati Dhingra in calling for a rate cut, which would move the vote split to 7-2, Morgan Stanley’s Skarica said.

In November, the only dissenter was Katherine Mann, who supported holding interest rates when the rest of the nine-member committee voted for a cut.

“Next year is about how the UK absorbs budget changes,” said Matthew Amis, investment director at abrdn. “If the private sector is able to pass on the additional costs to the consumer, it will be inflationary and we would struggle to see the Bank of England cut interest rates three times.”

Ames said he is heading towards the second scenario in which the private sector struggles to pass on the additional costs and resorts to job cuts. He said: “In this case, we believe that the file for gradually reducing interest rates seems unrealistic and the Monetary Policy Committee must accelerate the pace of reducing interest rates in the first half.”

The Bank of England now lags behind both the European Central Bank, which has cut its deposit rate four times since June to 3% from 4%, and the US Federal Reserve, which has cut twice – including a big half-point cut in September – To 3%. Range 4.5%-4.75%. The Fed may cut interest rates again on December 18, the day before the Bank of England meeting.

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The varying pace of interest rate cuts has caused cross-currents in currency markets. Earlier this week, sterling closed at its strongest level against the euro in more than eight years, while the spread between yields between government bonds and German peers is close to its widest in more than two years.

That would leave the Bank of England “between” the European Central Bank, which has been cutting interest rates rapidly as growth falters, and the Federal Reserve, which it expects will pause cuts in March, said George Buckley, an economist at Nomura Bank. Like most economists, Buckley believes the Bank of England will wait this month and cut rates by a quarter of a percentage point in February. “We see policy differences emerging,” he added.

“The Bank of England’s path looks a lot like the Fed – but one of those economies is growing at about 3%, and the other isn’t growing at all,” said Mike Riedel, portfolio manager at FIL Investment Management Ltd.

– With assistance from Tom Rees.

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