Market volatility and persistent inflation could derail plans for rate cuts this year
The Bank of England (BoE) finds itself at a critical juncture as market turbulence and stubborn inflation challenge its policy direction. While the Labour government’s economic strategy has taken much of the spotlight, economists suggest the BoE may need to reconsider the pace of its planned interest rate cuts to stabilise the economy.
Despite recent signs of economic strain, including rising unemployment and sluggish growth, the BoE faces pressure to maintain its inflation-fighting credibility. For British homeowners, the uncertainty could mean higher mortgage repayments than anticipated, adding financial strain to households already grappling with cost-of-living pressures.
“It is going to be increasingly difficult for the bank to have confidence in reducing interest rates further to the extent that the market had previously been pricing,” Nora Szentivanyi, global economist at JP Morgan, said during a Bloomberg TV appearance on Thursday. “The wiggle room for the bank is now much narrower, especially if we don’t get further fiscal consolidation.”
Since the start of the year, gilt yields have spiked, and the pound has weakened as concerns over stagflation mount. Investors are increasingly sceptical about the government’s ability to manage inflation and foster sustainable economic growth.
Labour’s £26 billion business tax hike and the rising minimum wage have added to inflationary pressures, as many companies warn they will pass on increased costs to consumers.
Adding to these pressures, energy and food costs continue to climb, raising fears of further inflation.
Britain’s market upheaval has put the spotlight on its Labour government this week, but economists say the Bank of England will also have to rise to the occasion by slowing interest rate cuts https://t.co/iksV87CJ9V
— Bloomberg UK (@BloombergUK) January 9, 2025
“The bank hasn’t dealt with inflation yet,” Erik Britton, managing director of Fathom Consulting and a former BoE economist, told Bloomberg. “Inflation has fallen but the second round effects are still in play. Private sector wage growth is unsustainably high, bond markets are saying that longer-term inflation has slipped from the bank’s grasp. They must address that to restore the credibility of inflation targeting.”
Deputy governor Sarah Breeden said on Thursday that recent data points to weakening activity and easing wage growth, suggesting room to withdraw policy restrictiveness.
Last month, BoE governor Andrew Bailey indicated that four quarter-point rate cuts might be appropriate by 2025, keeping policy at a restrictive level. However, markets are currently pricing in just two cuts, with the base rate potentially falling to 4.25% by year-end, though not all experts agree on the timeline.
Martin Weale, a former BoE ratesetter, cautioned against quick rate cuts in the wake of rising gilt yields.
“Cutting rates when the long end of the curve is rising sharply does not seem to be a good way to restore the confidence needed to bring the long end down,” Weale said. “And weakness in sterling would raise inflation fears.”
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