Analysts are divided about how far and how fast the Bank of England is likely to cut interest rates in the remainder of this year following yesterday’s decision.
Rate-setters backed a third 25 basis point rate reduction, which brought the Bank Rate down to an 18-month low of 4.5 per cent.
Every member of the Monetary Policy Committee (MPC) voted to lower borrowing costs, although two – Swati Dhingra and Catherine Mann – called for a larger 50 basis point cut.
Mann’s vote really put the cat among the pigeons, as she seemingly transformed from the MPC’s arch-hawk into a dove.
Analysts at Goldman Sachs said her decision was “particularly notable given that she had voted against the August and November cuts”.
The pound sunk and equities gained immediately after the decision, as investors priced in a faster pace of interest rate cuts in the months to come.
This sentiment was strengthened by new forecasts which showed that the economy is likely to be much weaker in 2025 than previously anticipated.
“The dovish shift at the Bank and the weak economy means the chances of faster and further cuts, perhaps to 3.00 per cent, have risen,” Paul Dales, chief UK economist at Capital Economics said.
Inflation on the rise?
But the forecasts also suggested that inflation will peak at 3.8 per cent later this year on the back of higher energy prices, only returning to target in late 2027.
Andrew Bailey, Governor of the Bank of England, said that the picture on underlying inflation remains positive and he suggested second-round effects – which would imply more persistent price pressures – were unlikely.
Nevertheless, the anticipated rise in the headline rate will still cause some discomfort on Threadneadle Street.
Source: Bank of Englnad
The forecasts were based on an implied path for interest rates which only prices in three rate cuts in total, which would see the Bank Rate fall to 4.0 per cent.
This implies that a faster pace of rate cuts – which many in the City have called for – would keep inflation above the two per cent target for even longer.
Rob Wood, chief UK economist at Pantheon Macroeconomics, said markets had drawn the wrong conclusion from the meeting.
“We think the market has gone too far in pricing a better-than-even chance of three more cuts in 2025,” he said. “We would ignore those dissenting votes from Swati Dhingra and Catherine Mann.”
Speaking to Bloomberg after the decision, Bailey said the vote split is not a “communication tool”, cautioning against reading too much into the decision.
However, other analysts noted that the vote split still revealed growing concerns about the health of the economy among the MPC. Alan Taylor and Dave Ramsden have now voted for back-to-back rate cuts, suggesting they will likely back another cut in March.
“March is now clearly a live meeting, with four members of the MPC having publicly aligned themselves with a faster-than-gradual pace of easing,” analysts at Barclays said.
The debate reflects the obvious difficulties facing the MPC, with growth having slowed significantly even while inflation looks set to rise.
The Bank of England’s forward guidance reflected the degree of uncertainty about the economic outlook, with officials retaining the option to cut rates at a faster pace if demand weakened significantly.