The Bank of England faces a particularly stubborn inflation problem that may stop it from cutting interest rates as sharply as peers next year, investors have warned, as the central bank prepares for its final policy meeting of 2023.
The Monetary Policy Committee is widely expected to say on Thursday that it is keeping its critical rate at a 15-year high of 5.25 per cent as it reiterates pledges to maintain a “persistently” tough stance on the cost of borrowing.
The MPC voted at its past two meetings in September and November to hold interest rates at that level, after raising them from historic lows since the end of 2021.
This week’s meeting comes against a backdrop of global speculation that the rate-lifting cycle by big central banks — which started after the end of Covid-19 lockdowns — is not only over, but could be reversed in 2024 as headline inflation indicators fall in advanced economies.
But economists have that warned the BoE faces a tougher job than peers such as the European Central Bank in returning consumer price inflation — now at 4.6 per cent — to the 2 per cent target.
“The evidence in the UK isn’t there for rate cuts in the near term,” said Ruth Gregory, deputy chief UK economist at the research company Capital Economics. “The MPC will be wary of causing the pound to fall and market interest rates expectations to shift decisively in favour of an even earlier cut.”
Investors do not see the BoE cutting its benchmark rate until June 2024 — later than the ECB and the US Federal Reserve, which are tipped to reduce their own main rate between March and May. As of the end of Friday, markets were pricing in about 130 basis points of cuts by the ECB and 100 by the Fed by the end of next year, but only 79 by the BoE.
Since its most recent meeting, the MPC has received some welcome data on price rises, with headline consumer price inflation falling sharply from 6.7 per cent in September. Wage figures have also eased somewhat, but leading policymakers have been insisting they are not jumping to conclusions.
Andrew Bailey, BoE governor, warned markets in November that they were underestimating how persistent inflation would prove. Meanwhile, Huw Pill, chief economist, told the Financial Times it was risky to put too much weight on one soft inflation reading, and that crucial indicators such as services inflation and pay growth remained at “very elevated levels”.
A number of indicators suggest the UK is finding it harder than the eurozone to bear down on price growth. Euro area headline inflation dropped to 2.4 per cent in November, close to the ECB’s target of 2 per cent, with many member countries reporting below-target price growth or deflation.
In the UK, inflation remains more than double the target, and analysts expect it to ease only gradually.
Economists polled in December by Consensus Economics, a company that collects leading forecasters, expect UK inflation to still be 3.6 per cent by March, higher than the 2.9 per cent for the US and 2.4 per cent for the eurozone. This is even more optimistic than the BoE’s own forecast, which has price growth still above 3 per cent by the end of 2024.
Other measures of UK price growth are running far higher, official figures show. Core inflation — which strips out more volatile food and energy costs — is higher in the UK at 5.7 per cent than in any other G7 country, as well as the eurozone, according to the Office for National Statistics.
Services inflation, which is considered a better measure of domestic price pressure, was 6.6 per cent in the UK in October. That is higher than the 4.6 per cent in the eurozone in the same month — it fell to 4 per cent in November — and above the 5.1 per cent in the US.
Wage growth, which the BoE is watching closely as an indicator of underlying pricing pressures, is also running hotter in the UK than in some peer countries.
An international tracker from jobs website Indeed shows posted pay growth dipped to 7 per cent year on year in October — down from 7.4 per cent in June but still much higher than in the US and the euro area.
Pay growth is close to 8 per cent in the UK, according to official figures, nearly double similar measures for the US and the eurozone.
Up-to-date official jobs and wage data on Tuesday will offer the MPC more clarity on the state of the labour market before its nine members vote.
While the BoE has cut its expectations for growth, predicting output will stagnate next year, Pill stressed that the downgrades were not necessarily a boost in the battle to tame inflation.
This is because officials have become less optimistic about the supply side of the economy, meaning more sluggish activity may not be associated with easing inflationary pressures.
However, with the UK entering a likely election year, officials fully expect to come under increasing pressure to lower interest rates if the economy continues to weaken.
Economists who argue that the threat of price rises is subsiding can point to favourable movements in inflation expectations of UK households. The BoE’s survey of public attitudes, published on Friday, showed Britons on average thought the rate of price growth over the next 12 months would be 3.3 per cent in November. That compares with 3.6 per cent in August, when the question was last posed, and was the lowest in two years.
One area of investor focus on Thursday will be the voting pattern of the MPC, which has been divided at recent meetings. Three members of the committee — Megan Greene, Jonathan Haskel and Catherine Mann — voted to increase the cost of borrowing last month, with the remainder opting to leave it unchanged.
Any defections from that hawkish contingent would be taken in markets as a signal that rate reductions are more likely next year.
Sanjay Raja, economist at Deutsche Bank, predicted the BoE would start cutting rates only from the second quarter of next year, but warned that “wage stickiness and upcoming changes to CPI could end up delaying the start of any easing cycle”.