The BoE’s Difficult Trade-Off – Reuters

By William Schomberg and Sumanta Sen

LONDON – The Bank of England is anticipated to maintain interest rates at their highest levels in 15 years as it confronts an inflation rate that significantly exceeds its target, despite emerging signs of economic strain.

Inflation in the UK remains the highest among developed economies, largely due to the Bank’s consecutive interest rate hikes—14 in total from late 2021 to August this year—aimed at curbing inflation. This strategy is beginning to impact the housing market, employment, and consumer spending.

The situation presents the central bank with a challenging dilemma as it seeks to bring inflation down to its 2% target without tipping the stagnant economy into recession.

Inflation Decline Slow

Consumer price inflation peaked at 11.1% in October 2022, outpacing other comparable economies and has since decreased more gradually, holding steady at 6.7% in September. While core inflation, which excludes volatile fuel and food prices, has decreased, service price inflation—a focus for the Bank—has climbed.

Governor Andrew Bailey remarked that the recent figures are generally in line with the Bank’s expectations. Economists predict a substantial decline in headline inflation for October, as the previous year’s energy price increases will no longer be a factor for comparison.

Nevertheless, the Bank of England projected in August that inflation would not return to the 2% target until the second quarter of 2025, with updated forecasts due for release shortly.

Cooling Wage Growth

Even as wage increases remain at their highest in over two decades, signs of cooling have emerged, with new data indicating a slowdown in starting salaries for job seekers recruited through agencies. Assessing the labor market has become more complicated due to issues affecting the UK’s statistics office in conducting its surveys.

Housing Market Affected by Rising Mortgage Costs

The UK’s housing market thrived during the pandemic, but rising mortgage costs have resulted in a noticeable slowdown in transactions and borrowing for home purchases, which adds further pressure on the broader economy. While house prices have declined approximately 5% since September, this decrease comes after a substantial 25% increase during the pandemic.

Consumer Spending Under Pressure

Retail sales have declined by nearly 1% in the three months leading up to September—the first notable drop since early 2023—and only partially reflects the impact of unseasonal weather. Economists warn that this underperformance heightens the risk of an economic contraction in the third quarter of 2023, potentially indicating the onset of a recession.

Consumer confidence plummeted in October, as households grappled with the ongoing cost-of-living crisis.

Future Rate Cuts Anticipated after Global Peers

The Bank of England stated in August that it would likely maintain high interest rates to ensure inflation is effectively managed, with its chief economist Huw Pill drawing comparisons to the lengthy flat summit of Table Mountain.

Currently, most investors appear to concur with this approach. Financial markets forecast a less than 50% chance of a rate cut by the Bank until August 2024, while U.S. markets predict the first rate reduction in June, and the European Central Bank is likely to lower borrowing costs before the Bank of England does.