The Bank of England has dropped the broadest possible hint that the next move in interest rates will be downwards after forecasting inflation will fall below 2% within months, despite keeping borrowing costs unchanged for a fourth consecutive time.
Threadneedle Street stressed that more evidence was required that inflation would stick at the target set by the government before the Bank could deliver a first cut to borrowing costs since the start of the pandemic. It warned that risks from fast-rising prices remained amid the cost of living crisis.
In a widely expected decision, the Bank’s monetary policy committee (MPC) voted by a majority to keep interest rates at the current level of 5.25%, the highest level since the 2008 financial crisis.
However, one member of the panel – the independent economist Swati Dhingra – pushed for an immediate reduction in borrowing costs, in a powerful signal to financial markets that the central bank was edging closer to taking action.
The Bank issued a sharp downgrade in forecasts for inflation, pencilling in a fall below 2% in May for the first time since early 2021, although it warned it was likely to return above the target rate later this year amid robust pay growth in the British economy and the fading impact from lower energy prices.
Andrew Bailey, the Bank’s governor, said: “We have had good news on inflation over the past few months. It has fallen a long way, from 10% a year ago to 4%. But we need to see more evidence that inflation is set to fall all the way to the 2% target, and stay there, before we can lower interest rates.”
Financial markets had predicted rates would be left unchanged for a fourth consecutive time after a steady decline in inflation over recent months, despite a small increase in December from 3.9% to 4%, with City investors anticipating a first rate cut from as early as June.
The Bank has left borrowing costs unchanged since September, having paused its most aggressive hiking cycle in decades. The central bank lifted rates from a record low of 0.1% in December 2021, driving up the cost of mortgages and loans for millions of households.
The prospect of interest rate cuts will provide a boost for Rishi Sunak as the prime minister prepares to send voters to the polls in a general election expected this autumn. Financial markets are anticipating a reduction in borrowing costs of up to 1 percentage point.
Interest rates and inflation falling as financial markets expect would also provide a tailwind for economic growth, with the Bank pencilling in a modest upgrade to its GDP forecasts from zero growth this year to about a quarter of a percentage point.
However, it warned inflation was only on track to fall “temporarily” below 2% this spring before rising back to about 2.75% before the end of the year and remaining above the target for the rest of its three-year forecast, fuelled by the “persistence of domestic inflationary pressures” in the services sector and labour market.
It also warned of risks over the coming months from disruption to shipping in the Red Sea amid the Israel-Gaza war, with the potential to drive up consumer prices in Britain.
“We don’t expect [inflation at 2%] to be the sustained level. It’s going to rise somewhat thereafter,” Bailey said. “This is not back to 10%, let’s be clear. But that’s not an acceptable state of affairs as a resting place, so it’s important we do the rest of the work.”
Exposing a three-way split on the committee amid concerns over the potential for inflationary pressures becoming entrenched, two members of the MPC – the independent economists Jonathan Haskel and Catherine Mann – pushed for a further quarter-point increase in the Bank rate. A majority of six members – including Bailey – voted to keep rates on hold.
Reflecting concerns over stubbornly high inflation, the Bank highlighted robust levels of wage growth expected this year in surveys conducted by its network of agents across the country, which found companies were planning to offer pay settlements of about 5.4% this year, only slightly below the levels seen in 2023.
It also insisted that borrowing costs would “need to be restrictive for an extended period” to return inflation sustainably to its 2% target, while indicating that it was prepared to keep them under review before taking action.
Bailey said the question was how long the Bank needed to maintain rates at elevated levels, but added: “It is too soon to take that decision, we need some more evidence.”
