Economic Uncertainty Looms as Bank of England Prepares to Cut Interest Rates
The Bank of England is poised to slash interest rates next week, with economists and investors alike anticipating a benchmark rate reduction to 4.5% from 4.75%. This move comes as the UK economy stagnates and key inflation measures decline.
Mixed Signals from Economic Data
Since the Bank of England’s last projections in November, the economy has flatlined, and measures of inflation closely watched by rate-setters have dropped. However, wage growth has unexpectedly accelerated, sending mixed signals about the outlook. Investors will be keenly watching for any changes in the views of Monetary Policy Committee members, who may provide insight into the inflation outlook.
Employers’ Response to Payroll Tax Hike in Focus
A key question for the inflation outlook is how employers will respond to the government’s October 30 budget, which imposed a significant hike in payroll taxes from April. Rate-setters may offer an early indication of their thinking on this crucial issue.
Shifting Rate Expectations
Financial markets have priced in almost three quarter-point BoE rate cuts this year, up from fewer than two in early January. This shift is driven by changing US rate expectations ahead of President Donald Trump’s inauguration and concerns about Britain’s public finances. The sell-off has put pressure on finance minister Rachel Reeves to reassure markets that she will act to meet her fiscal rules if needed.
Dovish Turn Ahead?
Expectations for BoE rate cuts may be too incremental for the MPC’s liking, with some members likely to emphasize risks from a weak economy and a worsening outlook in the euro zone. The European Central Bank has already reduced rates four times since mid-2024, and is expected to deliver a fifth cut soon.
Impact on the Pound and Business Community
A dovish statement from the BoE is likely to keep the pound under pressure in the near term, but would also provide comfort for investors and the business community. Public comments from MPC members have been scarce, but those who have spoken have tended to stress the potential for lower interest rates.
Timing of Cuts Uncertain
Deputy Governor Sarah Breeden has said that economic data supports the BoE’s message of gradual cuts, but the timing is uncertain. Short-term market interest rates have fallen recently, but remain sharply higher at the two- and three-year horizons compared with the rates that underpinned the BoE’s November forecasts.
Room for Further Rate Cuts
Weak economic growth may make it harder for companies to pass on the cost of tax hikes to consumers, making it easier for the Bank of England to look through a near-term rise in inflation and deliver more rate cuts than currently priced in. A business survey this week showed workers are likely to bear the brunt via slower wage increases.
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