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Upgrade to Premium BOE Delivers Rate Cut With Warning on Budget’s Inflation Hit
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BOE Delivers Rate Cut With Warning on Budget’s Inflation Hit
Philip Aldrick and Andrew Atkinson Thu, Nov 7, 2024, 7:15 AM 4 min read
(Bloomberg) — The Bank of England cut borrowing costs for the second time this year, but stopped short of signaling faster easing, warning that the budget could drive up inflation by as much as half a percentage point.
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Eight members of the Monetary Policy Committee led by Governor Andrew Bailey voted to lower the benchmark interest rate by a quarter point to 4.75%. Catherine Mann, one of its external officials, was the lone dissenter, preferring to hold at 5%. The outcome was widely anticipated by economists.
“We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much,” Bailey said in a statement on Thursday in London. “But if the economy evolves as we expect, it’s likely that interest rates will continue to fall gradually from here.”
The pound edged up after the decision while two-year UK bonds held gains. Traders are fully pricing two more quarter-point reductions by the end of next year, with just under a 50% chance of another.
The BOE’s path to further easing has been complicated both by Chancellor of the Exchequer Rachel Reeves’ Oct. 30 budget and the election of Donald Trump as US president. The UK now plans a £70 billion ($90.4 billion) a year spending binge, almost half of which is financed by borrowing. Trump is threatening higher tariffs in a new global trade war.
Bond markets have taken fright, with UK government borrowing costs hitting one-year highs since the budget. That stirred memories of the financial meltdown triggered in 2022 when then-Prime Minister Liz Truss’ £45 billion of unfunded tax cuts rattled investors.
The recent large market moves meant that the BOE based its forecasts on a lower path for borrowing costs than now priced. Using an implied outlook for interest rates to fall to 3.7% by the end of next year and remain there, officials see inflation above the 2% target, at 2.2% after two years. It then slows below the goal to 1.8% in the course of 2027.
Markets now see rates remaining almost half a percentage point higher, which would imply a sharper slowdown in consumer price growth, and potentially greater BOE action.
Even so, the committee retained its guidance that “based on the evolving evidence, a gradual approach to removing policy restraint remained appropriate.”
The BOE reduction precedes a step of the same size seen likely from the Federal Reserve later on Thursday, in the first US decision since Trump’s victory. Earlier in the day, Sweden’s Riksbank ramped up easing with a half-point cut, while Norwegian officials kept borrowing costs unchanged.
In the quarterly Monetary Policy Report that accompanied the BOE decision, policymakers estimated that Reeves’ budget will drive up inflation by half a point compared with its August forecast, peaking at 2.8% in the third quarter of 2025.
Consumer price growth is currently below the 2% target at 1.7%, but the forecasts show higher energy prices lifting it to 2.5% by December. The budget stimulus also lifts the level of UK gross domestic product by 0.75% at its peak impact next year.
Policymakers voted on Wednesday shortly after the results of the US election became clear, but the account of their deliberations makes only limited reference to the risks of a trade war.
There are “upside risks to goods and commodity prices from greater trade fragmentation and adverse geopolitical developments, including from events in the Middle East,” the MPC minutes said.
Reeves’ budget caused further uncertainty. The BOE sees impacts on wages, profit margins and jobs from the 6.7% increase in the National Living Wage that starts in April next year, and a £26 billion increase in national insurance contributions for employers, a payroll tax.
Officials will be watching to see how much is taken in squeezed profit margins, how much in lower pay and how much in higher prices. The BOE added that some of the recent steep fall in services inflation was “expected to unwind.” The labor market “continues to loosen, though it appears relatively tight by historical standards,” it added.
–With assistance from Constantine Courcoulas.
(Updates with markets reaction in fourth paragraph.)
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