Interest rates held at 5.25% - what is the bank waiting for?

The prize of returning inflation to the Bank of England's target of two percent is, the bank says, within its grasp. But the Bank won't be cutting interest rates just yet

“The last mile will be the hardest,” the Governor of the Bank of England warned last summer.

The journey to price-stability since then has proved far less arduous.

The Bank of England now forecasts that the headline annual rate of inflation will be back at the target rate 2% by May, a year and a half sooner than it was expecting just three months ago.

The market price of oil and gas has fallen significantly since November, inflation is fading fast.

There’s strong possibility that the UK economy entered a technical recession at the end of 2023 (probability: a coin’s toss) and growth this year and next is forecast to be dismal.  

The markets spy interest rate cuts. Investors are betting that the Bank Rate - currently 5.25% - will be back at 4% by the end of 2024.

But the Bank of England believes it’s still too early to declare victory.

“We’ve had good news on inflation over the past few months,” says the Governor, Andrew Bailey.

“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."

Business and Economics Editor Joel Hills analyses the Bank of England's decision to hold UK interest rates

The language has changed. At least the prospect of interest rate cuts is now being acknowledged. 

The clear message appears to be that rates have probably peaked, that the next move will be down - it’s just a question of when. 

One member of the Monetary Policy Committee, Swati Dhingra, voted for an immediate cut. But two, Jonathan Haskel and Catherine Mann, wanted another increase.

The Bank’s concern is that although inflation is likely to return to 2% in the summer, it’s unlikely to stay there. From July, the Bank thinks inflation will be rising again, nearing 3% in March 2025.

The economic shocks which propelled prices upwards - the pandemic and Russia’s invasion of Ukraine - have eased but the evidence suggests inflation continues to feed itself domestically.

Annual wage growth and Services Price Inflation both remain above 6% – a level the Bank is not prepared to tolerate. 

Put another way: households and businesses continue to try to reclaim their lost spending power by increasing their pay and their profits in a way the Bank still considers to be inflationary.

The Bank’s survey of 530 companies, which employ almost one million people, suggests the average pay rise in April will run at 5.4%. In the Bank's view, that puts upward pressure on prices. 

Wage growth has eased and the Bank expects it to decline further but it wants to see proof that’s happening. For now, interest rates stay where they are.

The strength of pay growth is not the only worry. 

The attacks on shipping in the Red Sea remain a “material risk”. The price of shipping freight between Asia and Europe has almost quadrupled in the last three months but, for now, the impact on consumer prices in the UK is judged to be small.

The Bank’s aim here is to keep applying the appropriate amount of restraint on demand to bring inflation under control while causing the minimum amount of distress.

And higher interest rates are causing distress, for many households and businesses. With 1.6 million mortgages set to be repriced this year, monthly repayments are set to rise sharply.

Today, the Bank finally opened the door to interest rate cuts. There are plenty people willing it to walk through.

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