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UK interest rates are on a “gradual downward path” — but potentially not for much longer.
That was the key message Bank of England governor Andrew Bailey gave on Thursday as he presented a new-look set of economic forecasts, offering more clarity than the central bank has given on rate-setters’ view of the future path of policy.
For the first time, members of the Monetary Policy Committee set out the rationale underpinning their individual votes after deciding by a five to four majority to leave the BoE’s benchmark rate on hold at 4 per cent.
Bailey wrote current market pricing — implying two further rate cuts to leave the Bank rate at 3.5 per cent in three years’ time — was “a fair description of my position at present”. He added market pricing gave “a reasonable view of a sensible path”.
His comments reinforced expectations that the BoE will lower interest rates once it can assess the impact of tax decisions taken in the Budget on November 26 and can see a longer run of data to confirm inflation is finally easing.
But the remarks also suggest interest rates may level out at a higher rate in the UK than in either the US or the Eurozone.
Allan Monks, chief UK economist at JPMorgan, said: “It does feel like they are converging towards a view on a terminal interest rate that is higher than I can remember BoE policymakers arguing in the past.”
He added: “Some have previously pointed towards a neutral rate of 2 per cent or 3 per cent, but the conversation seems to be shifting towards the 3 to 4 per cent range. That is a big shift that is relevant for the policy outlook.”
With the MPC split into two camps — one focused on the risks of high inflation expectations and persistent wage pressures, the other on rising unemployment and weak consumer spending — Bailey emerged as the swing voter, signalling he would favour a cut if inflation continued to ease.
“I want to see more evidence,” the BoE governor said after the decision, but added the “two big risks” troubling the committee had “become more balanced” since the summer.
Paul Dales, chief UK economist at the consultancy Capital Economics, said this suggested Thursday’s vote was “a pause in the downward trend in interest rates rather than the end”.
But the BoE had also signalled it would need “convincing evidence” to cut rates further than 3.5 per cent, he added.
The European Central Bank’s benchmark rate is set at 2 per cent. In the US, the median forecast among Federal Reserve policymakers for their key interest rate over the longer term is 3 per cent.
Some analysts believe the BoE will eventually cut interest rates further than Bailey signalled.
Andrew Goodwin of Oxford Economics said he believed the MPC would ultimately lower rates to somewhere between 2.5 per cent and 3 per cent. “There is a fair way to go yet,” he said. But he said given the stickiness of inflation and uncertainty about the economic outlook we could see prolonged periods of pausing in between rate moves, he predicted.
Bailey insisted he had no pre-determined view on where interest rates would settle, arguing that attempts to calculate the so-called neutral rate — where policy is neither stimulating nor constraining the economy — are too uncertain to be of practical use when setting policy.
At present, the MPC still believed policy was restrictive, he added, but it would need to make a new judgment on this each time it met — and some were more willing than others to take a view on where the neutral rate lay.
Clare Lombardelli and Dave Ramsden, two of the BoE’s deputy directors, gave a similar message, saying the committee was increasingly grappling with the question of where the “neutral” or “terminal” rate might lie.
“There is a difference of views,” Lombardelli said. “Determining how restrictive you are . . . is quite challenging. It gets more challenging as you lower rates.”
Ramsden said: “We would all agree we’re getting closer to the neutral rate, or the terminal rate . . . The debate and the way we’re thinking about this is inevitably going to evolve and change in future.”
