BoE holds rates steady as ECB signals caution

Bank of England

The BoE’s decision was very much expected, with various Monetary Policy Committee (MPC) members consistently noting areas of concern on inflation, including wage growth and services prices. Yesterday’s Consumer Price Index showed headline inflation eased again in February, slowing to its lowest level in almost two and a half years. Core inflation also slowed quite quickly but remains more than double the Bank’s target of 2.00%, and services inflation remains elevated. Meanwhile, despite the economy entering a shallow recession in the second half of last year, unemployment is still historically low and there are more job vacancies than before the pandemic, supporting higher wage demands and allowing the BoE to be patient with cutting interest rates.

Nevertheless, the Bank’s MPC is aware of the risks to the economy of keeping policy too restrictive for a prolonged period, stating that they would "continue to consider the degree of restrictiveness of policy at each meeting." While one member, Swati Dhingra, feels there is room to cut rates, another four members share her views. The statement noted some members felt “there were limited signs so far that services price inflation would return to a target-consistent pace sufficiently rapidly, with evidence of diminishing second-round effects still tentative." Governor Andrew Bailey also said that "we are not yet at the point where we can cut rates, but things are moving in the right direction."

U.K. two-year interest rates were down approximately five basis points following the decision, while GBP was slightly weaker. Market implied rates still show 75 basis points of rate cuts this year.

European Central Bank

The ECB kept deposit and borrowing rates at record highs of 4.0% and 4.5% respectively, while cautiously paving the way to lower them later this year. Having underestimated sharp price surges two years ago, the ECB has been reluctant to declare victory, unwavering on its position to keep rates at historically high levels.

In updated staff forecasts, the ECB expects inflation for this year to be 2.30%, down from its December forecast of 2.70%, while also lowering its 2025 forecast. New ECB forecasts that point to lower inflation and lower growth has led policy makers to signal they will cut rates, provided incoming data remains consistent with the disinflationary trend. In a press conference post the decision, Lagarde said “we will know a little more in April, but we will know a lot more in June.”

Moving forward

Recent data on the U.K. economy points to a rebound in activity this year, which could be attributed to the decline in forward interest rates due to expectations that rates will be cut in the coming months, making it cheaper for companies and individuals to borrow money. This arguably buys the BoE breathing room to see how inflation develops over the next few months, as well how double digit increases in the national living wage impact broader pay settlements. One factor to watch will be the political pressure to cut rates that will undoubtedly build — especially from the Conservative Party — if inflation does continue to slow.

There is likely to be a growing divide among ECB policy makers, between those who are more concerned with getting inflation back to 2.00% and keeping it there, and those who want to stimulate economic growth following a year of stagnation. With the more hawkish members of the Governing Council holding sway for the past six months, it may be time for the dovish members to make their case for easier monetary policy to get the economy moving again.