Bank of England opens door to rate cuts but calls for ‘more evidence’ of falling inflation

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The Bank of England opened the door to interest rate cuts but said it first required “more evidence” that inflation would continue falling, as it held borrowing costs at 5.25 per cent.

After a meeting of the Monetary Policy Committee, the BoE signalled on Thursday it was ready to consider cutting rates for the first time since inflation surged following the coronavirus pandemic.

With headline inflation now 4 per cent compared with its 2022 peak of more than 11 per cent, the bank has ditched its previous warnings that “further tightening” of monetary policy might be needed. Instead, the BoE said it would “keep under review” how long rates should be held at current levels.

The meeting marked a pivot more than two years after the central bank embarked on an aggressive rate-raising campaign that took borrowing costs to their highest level in 15 years.

BoE governor Andrew Bailey said the bank had seen “good news on inflation over the past few months”.

But he cautioned: “We need to see more evidence that inflation is set to fall all the way to the 2 per cent target, and stay there, before we can lower interest rates.”

Bailey said that, with service price inflation still high and the negative contribution of falling energy prices set to fade in coming months, the BoE could not yet declare that “the job is done”. 

Traders scaled back their bets on spring rate cuts after the announcement. Swaps markets were pricing in a roughly 55 per cent chance of a reduction by May, down from 60 per cent earlier in the day.

Both the US Federal Reserve and the European Central Bank have signalled in recent days that they will hold off rate cuts until they see more evidence that inflation is fully under control.

Fed chair Jay Powell said on Wednesday that cuts in March were not his central bank’s “base case”.

In a sign of the continued debate within the MPC, two members voted for further rate rises while another opted for an immediate cut. The majority voted for rates to be held unchanged at 5.25 per cent for the fourth meeting.

The benchmark FTSE 100 share index barely moved following the BoE’s announcement, edging up 0.3 per cent. The mid-cap FTSE 250 was 0.4 per cent lower. 

The BoE forecast that consumer price inflation would “fall temporarily” to its 2 per cent target in the second quarter before increasing during the remainder of this year.

It warned that headline inflation would remain “above target over nearly all of the remainder of the forecast period”, at 2.3 per cent in two years’ time and 1.9 per cent in three years’ time.

Such predictions suggest the central bank does not expect rates to be cut as aggressively as some investors have been assuming.

The new BoE outlook is being closely watched by chancellor Jeremy Hunt, since a fall in borrowing costs could increase his scope for cutting taxes ahead of his March 6 budget.

But Hunt told the BBC that he did not expect to have the same latitude for tax cuts as in November’s Autumn Statement, when he reduced national insurance contributions.

The BoE reiterated that monetary policy would need to remain “restrictive for sufficiently long” to return inflation to the 2 per cent target on a sustainable basis.

The central bank stressed that, while the labour market had cooled, with risks from domestic wage and price pressures now “more evenly balanced”, it remained “tight by historical standards”.

The BoE upgraded its forecast for 2024 growth, which it now says will be 0.25 per cent — up from its previous prediction of zero growth. It forecasts 0.75 per cent growth for 2025.

One MPC member, Swati Dhingra, called for a quarter-point reduction in interest rates, saying inflation was now on a “firm downward trajectory”.

Her vote for an immediate cut prompted the MPC’s first discussion of the merits of lowering rates since the rate-raising cycle began in 2021.

Megan Greene, who previously advocated higher rates, fell into line with the majority in advocating unchanged rates at the meeting. Two other MPC members — Jonathan Haskel and Catherine Mann — continued to demand a further quarter-point increase.

Additional reporting by Delphine Strauss