Cautious Bank of England Maintains Rates and Extends Bond Reduction Plan, According to Reuters

By Andy Bruce and David Milliken

LONDON – The Bank of England maintained its interest rates at 5.0% on Thursday, indicating a cautious approach towards future cuts. Additionally, it decided against accelerating the reduction of its bond holdings, thereby alleviating potential budget pressures for Finance Minister Rachel Reeves.

The Monetary Policy Committee (MPC) voted 8-1 to keep rates unchanged, with only external member Swati Dhingra advocating for a further quarter-point cut after the BoE implemented its first decrease in borrowing costs since 2020 last month.

Economists surveyed had predicted a 7-2 vote to maintain the current rate following the previous month’s narrow 5-4 decision to lower rates from their highest level in 16 years.

In response to the announcement, sterling briefly rose above $1.33, reaching its highest point since March 2022, while investors adjusted their expectations regarding additional rate cuts.

On the preceding Wednesday, the U.S. Federal Reserve announced a more significant than anticipated cut of 0.5 percentage points, reflecting its belief that inflationary pressures are easing.

BoE Governor Andrew Bailey expressed a cautious outlook, noting that wage growth remains high and policymakers are divided on the pace at which long-term inflation pressures are diminishing. "It’s vital that inflation stays low, so we need to be careful not to cut too fast or by too much," he remarked.

Bailey later conveyed optimism that rates would decrease further, although he emphasized the need for more evidence of waning price pressures before proceeding.

Market participants believe the BoE will adopt a slower rate-cutting strategy compared to the Fed. Luke Bartholomew, Deputy Chief Economist at a major fund manager, pointed out that underlying inflation pressures in the UK remain elevated, and the labor market presents mixed signals regarding economic health.

The BoE projected that inflation might rise to approximately 2.5% by the end of the year, slightly up from the recent figure of 2.2%. This adjustment is less than their previous forecast of around 2.75%, with lower oil prices contributing to the revision.

Additionally, the BoE’s analysis suggested that unemployment may have increased more significantly in recent quarters than the official data indicates, which has been impacted by low response rates. Nevertheless, the MPC concluded that the labor market overall remains tight.

Following the announcement, investors no longer fully expected two rate cuts by the end of 2024, although they anticipate the BoE will reduce rates in quarter-point increments four or five more times by June. In contrast, they predict around seven such cuts in the U.S.

QT CONTINUES

The MPC unanimously agreed to decrease its government bond holdings by an additional £100 billion between October 2024 and September 2025, consistent with the reduction initiated over the past year.

Between 2009 and 2022, the BoE purchased £875 billion of gilts as part of its quantitative easing program aimed at stimulating the economy. The upcoming round of quantitative tightening (QT) will bring this total down to £558 billion.

Some investors had anticipated a speedier QT, given that the BoE holds £87 billion in gilts set to mature naturally in the next year, leaving just £13 billion available for active gilt sales at the current pace.

Critics, including lawmakers and think tanks, have raised concerns over QT, stating it accelerates losses incurred by the BoE, which bought gilts at significantly higher prices than their current sale value, with those losses ultimately underwritten by taxpayers.

Furthermore, the BoE incurs losses from interest payments on the reserves issued to finance gilt purchases. With the Bank Rate set at 5%, these interest expenses currently far exceed the returns generated by the bonds.

Many economists suggest that Finance Minister Rachel Reeves may revise Britain’s fiscal rules to exclude the impacts of QT in her first budget on October 30, potentially providing her with several billion pounds in additional fiscal leeway.

Bailey noted he had no concerns regarding this potential adjustment and asserted that fiscal considerations did not influence the BoE’s QT decisions.

James Sproule, UK chief economist at a Swedish bank, remarked that the reduced level of active sales compared to the previous year would assist Reeves by lowering the compensation owed to the BoE.