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The Bank of England closed the door on raising interest rates further today, but the central bank did not go so far as to suggest that interest rates would be cut in the immediate future.
Its decision to keep rates unchanged for the fourth consecutive meeting raises the obvious question: When will interest rate cuts begin?
Policy makers did not answer this question directly, but they did give some hints about the factors involved.
On the one hand, Andrew Bailey noted significant progress on inflation since the last Monetary Policy Report (MPR) in November. Inflation currently stands at four percent, which is lower than the 4.6 percent expected by the bank.
On the other hand, several indicators of domestic pressures – such as wage growth and services inflation – remain so high that it is difficult to be confident that inflation is falling sustainably to two per cent.
“Things are moving in the right direction,” he said. “But we need to be more confident that inflation will fall fully to the two percent target and stay there.”
Remaining at two percent is a major problem for the bank.
Its latest round of forecasts, released today, suggests inflation will rise to two percent in the second quarter, before rising again in the second half of the year.
The sharp decline in headline inflation over the past few months reflects the sharp decline in energy prices. This is expected to continue in the coming months, bringing inflation down to two percent.
But as the impact of falling energy prices fades, underlying inflation will prove relatively stubborn.
It is important to note that the increase expected later this year is not a major revival, but the Bank’s caution on cutting rates reflects concerns that inflation could slip above the two percent target.
“It’s not as simple as just getting inflation to the target level in the spring and being done,” he said.
However, Bailey said the decision-making framework has changed. “The main question becomes how restrictive the policy needs to be, for how long (interest rates) need to remain at this level,” he said.
So what will the bank have to do to reduce the rates?
In short, the bank wants to see more progress on its key measures of domestic inflation – wage growth and services inflation. When inflation is domestically driven it may be difficult to reduce it, hence the bank’s concern.
After starting to decline gradually over the past few months, services inflation stands at 6.4 per cent. Bailey warned that services inflation “will remain persistent”.
How will you reduce services inflation? The MPR suggests that “a reduction in wage pressures is likely to be required to bring services inflation back to target rates”.
The good news is that like services inflation, wage growth has also started slowing down. According to the latest figures from the Office for National Statistics (ONS), annual wage growth is 6.6 per cent, down from a high of 8.5 per cent last summer.
The bad news is that it is still some way from being in line with the Bank’s two percent inflation target, while forecasts have also flagged potential factors that could lead to higher wage growth.
The Bank’s own surveys suggest that wages will decline only “slightly” in 2024. It also acknowledged the potential impact of the rise in the National Living Wage, which comes into effect in April.
However, the impact of the living wage is likely to be much smaller. It says, “Relatively low levels of coverage, low rates of pay compared to average wages, and the fact that employers have implemented pay increases independent of the NLW all reduce the direct impact on total pay.”
Looking at the Bank’s key indicators, the message appears to be that the UK is moving in the right direction, but we are not there yet. However come summer and it will likely be a different story.
Source: www.cityam.com
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