Why did the Bank of England hold interest rates steady and when could they fall?

The Bank of England kept its key interest rate at 5.25 percent on Thursday after hawkish sentiment derailed hopes of a cut in March.

The Monetary Policy Committee voted to leave the base rate unchanged by a six-to-three margin, with two members voting for another 25 basis point increase to 5.5 percent, as recent data failed to address concerns about wage growth and to eliminate services inflation.

The BoE still thinks consumer price inflation will ‘temporarily’ fall back to 2 percent in April as the impact of previous increases takes effect.

But the CPI, which fell to 4 percent in December, is expected to rise again to 2.75 percent by the end of the year and remain above the bank’s target of 2 percent until 2027.

“This reflects continued domestic inflationary pressures despite increasing levels of slack in the economy,” the bank said.

Governor Andrew Bailey added that the BoE needs to see “more evidence that inflation will fall further and remain low” before the bank can “declare victory” and start cutting rates.

The bank has repeatedly warned that investors expecting an upcoming base rate cut were too ambitious, and MPC’s aggressive tone forced a rethink of market prices.

Markets had expected a cut of as much as 125 basis points by the end of the year, which would have brought the base rate to 4 percent.

However, after the MPC meeting, prices suggested rate cuts would be closer to 100 basis points, leaving the base rate at 4.25 percent at the end of 2024.

However, Bailey left room for optimism, telling reporters that the MPC was now actively considering when to cut rates.

He said: ‘For me the most important question has shifted from ‘how restrictive should we be?’ to ‘how long should we hold this position?’.’

Inflation forecast

The BoE expects the CPI to rise from 2 percent in April to 3.6 percent in the first quarter of next year.

It doesn’t expect this year’s figure to start below target until at least 2027, when it expects a CPI of 1.9 percent.

While both wage inflation and services inflation have fallen significantly from their peaks, the BoE is concerned that both measures remain ‘significantly high’.

Annual wage growth excluding bonuses was 7.3 percent in the third quarter of 2023, compared to a record 7.8 percent in the previous three months.

Services inflation was also very stable: prices were 6 percent higher year-on-year in December, unchanged from the previous month.

The BoE will keep a close eye on these measurements when new data from the Office for National Statistics is published this month.

It pointed to a survey of companies that showed that the average wage settlement in 2024 would be only slightly lower than in 2023, at 5.4 percent.

According to the minutes of the last meeting of the MPC: ‘While services price inflation and wage growth had fallen slightly more than expected, key indicators of inflation persistence remained high.

‘There were questions, which would require further evidence, about how deep-rooted this persistence would be, and therefore about how long the current level of bank rates should be maintained.’

Economic growth prospects

While the BoE’s main priority is to get CPI rates under control, the bank will keep a close eye on weakness in the UK economy as it weighs the timing of its first rate cut.

According to the latest available ONS data, Britain’s gross domestic product is estimated to have shrunk by 0.1 percent between July and September, downgraded from previous estimates of flat growth.

Britain is not alone in suffering from sluggish growth, with the US economy a rare outlier among comparable markets, while the eurozone continues to tread water.

But the BoE said: ‘Following recent weakness, GDP growth is expected to strengthen gradually over the forecast period, largely reflecting the waning drag on the growth rate from previous bank rate increases.

‘Business surveys are consistent with improving prospects for activity in the near term.’

However, GDP is expected to grow by just 0.2 percent in 2024, 0.75 percent in 2025 and 1 percent in 2026, with growth lagging that of Britain in the world.

The unemployment rate is also expected to rise ‘gradually’ from the current level of 4.2 percent to 4.4 percent in 2024, and to 4.7 and 4.9 percent in the following two years.