BoE and ECB keep rates on hold, but rate cuts grow more likely

Bank of England

As expected, the BoE voted to keep rates on hold at a near 16-year high of 5.25%, though the voting contained a surprise. Two MPC members continued to vote for a 25-basis-point-rate increase (down from three in December), while one voted for a 25-basis-point-rate cut, the first since an emergency rate cut when Coronavirus was declared a pandemic.

Governor Bailey said the BoE will not maintain the current policy stance any longer than needed, but “We need to see more evidence that inflation is set to fall all the way to the two percent target, and stay there, before we can lower interest rates.” The Bank dropped the following sentence from its statement, indicating that rate hikes were now unlikely, "Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures."

U.K. inflation has fallen to 4.00% — from a peak of 11.00% — but services inflation has proven very sticky, and this remains something the BoE is concerned about. In their latest forecasts, headline consumer price inflation slows back to their 2.00% target in the near-term, before rebounding, amid robust pay growth and the fading impact from lower energy prices.

The BoE seems to be more concerned with upside inflationary risks, rather than the strain on the economy from high rates. Having greatly underestimated the severity of the price shock of the last two years, the Bank is signalling it won’t rush to cut rates, while pay growth is still running well above average and geopolitical risks could drive energy prices higher.

Markets continue to expect the next move in interest rates to be lower, but following the Bank’s meeting, investors now expect the first cut in June, rather than announced in May’s meeting.

European Central Bank

As expected, the ECB left rates on hold at its first meeting of 2024. Since price pressures have not been fully extinguished and the picture on wage growth remains uncertain, the Central Bank is remaining steadfast that it is too soon to discuss cutting rates.

Policymakers agreed that inflation trends are encouraging but drew different conclusions — with some making the case for cutting rates soon, while others argued to wait until they had further confirmation that inflation was under control.

From the accompanying statement, the removal of the reference to an “elevated domestic price pressures and strong labour cost growth”, revealed a small but important change that pointed to a more dovish outlook for policy. President Lagarde did her best to downplay its significance, but the statement was agreed by consensus, suggesting those with a preference for easing rates are growing in number.

The recent weakening in economic activity and its expected disinflationary impact appears to be becoming a greater focus for several policymakers, influencing how tight they think monetary policy should be.

Lagarde said growth risks were tilted to the downside, highlighting the restrictive effect of monetary policy, along with the wars in Ukraine and the Middle East and weaker global demand.

The market consensus is that the ECB will likely cut rates at their June meeting. However, following the January meeting, several ECB governors have signalled their willingness to cut rates at the April meeting, making it a close call. The next two inflation releases will, therefore, play an important role in the timing of when the Central Bank ultimately cuts rates.

Moving forward

With global inflationary trends heading in the right direction, central banks are getting more comfortable with the idea that tight monetary policy has done its job. Meanwhile, the financial system has continued to function, and the majority of companies have held onto their staff, preventing a sharp fall in economic growth.

The challenge now is getting the timing right for lowering borrowing costs with inflation not yet at the 2.00% target. History suggests that the longer borrowing rates remain at elevated levels — relative to the level when the tightening began — the greater the economic pain. Rate cuts, it seems, are now just a matter of time.