BOE Receives Warning After Year of Failing to Deliver on Standards

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(Bloomberg) – The Bank of England entered the year with investors expecting six interest rate cuts, a sudden relief that promised to breathe life into the UK economy. It will end 2024 to hold borrowing costs a full percentage point higher than the forecast 12 months ago.

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Britain’s central bank is expected to leave rates unchanged at 4.75% at its meeting on Thursday and maintain its guidance that “a slow pace of easing policy remains appropriate.” While BOE Governor Andrew Bailey has said four cuts through 2025 are possible, markets – perhaps weighed down by their aggressive bets last year – have priced in only three, as of February.

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The December 19 decision, in what is expected to be a wait-and-see meeting, will end a year very different from the one predicted by traders and some economists in January when Britain was emerging from a mild recession with rates at 16. – in senior year.

After that, markets were predicting a six-point cut to 3.75% in 2024 – an approach endorsed by Goldman Sachs economist Sven Jari Stehn. Instead, the BOE did just two, in August and November, as officials worried that the rapid easing of the labor market posed a greater risk to inflation.

Their reluctance to lift the brakes has left the BOE lagging behind the easing of its US and eurozone counterparts and has made the pound the best-performing Group of 10 currency this year.

The result is that monetary policy has slowed down significantly on inflation, which has fallen faster than the BOE forecast and is now just above the 2% target. Bailey said it’s a sign of success.

But businesses, consumers and homeowners blame the bank for causing unnecessary pain. The BOE even came under political pressure to cut rates ahead of July’s general election, when the then Conservative chancellor, Jeremy Hunt, repeatedly called for cheaper money as he sought to stimulate the economy. His intervention has been criticized by economists and former officials for interfering with the central bank’s independence.

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Prices at the beginning of the year were heavily influenced by developments in the US. Financial markets are betting that both the BOE and the Federal Reserve will deliver one-and-a-half point cuts. Expectations quickly changed after it became clear that the US economy was much better than expected, and that the BOE was not sure it had won the battle to reduce price pressures in the services industry.

The Monetary Policy Committee once again heads into the new year with little clarity on the outlook and the economy at the crossroads. By 2024, the UK election was hanging over the idea. Now, incoming US president Donald Trump is threatening a global trade war while, internally, the Labor government’s first budget in October left unanswered questions.

Business and consumer sentiment have weakened significantly since the budget, when Chancellor of the Exchequer Rachel Reeves announced a £26 billion ($32.9 billion) tax hit for employers. Meanwhile, growth has stagnated and inflation is showing signs of picking up. That is a policy complication for the bank, which has “expressed uncertainty about the passage of monetary measures,” said Bank of America UK economist Sonali Punhani.

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Depending on how businesses respond to the payroll tax hike and other big increases in the minimum wage, inflation could be strong or growth could be weak. Labor also borrowed more money to boost public investment, which the Office of Budget Responsibility and the BOE judge will raise rates.

“The bulk of the MPC seems content to simply watch for near-term developments and meet again in February, perhaps with more certainty about the way forward,” said Morgan Stanley’s UK chief economist Bruna Skarica.

A flood of data this week could help clear things up. Consumer price figures on Wednesday are forecast to show inflation rising 0.3 percent to 2.6 percent in November. That’s above the BOE’s 2.4% forecast, which expects inflation to accelerate in energy prices before retreating toward its target. Economists see services inflation remain stubbornly high at 5.1%.

Average wage growth, another gauge of prevailing pressures, is expected to rise slightly to 5% when jobs data is released on Tuesday. The BOE’s consensus is that wage growth of more than 3% or so is not consistent with 2% inflation.

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Morgan Stanley’s Skarica said any sign of employment slowing could prompt new MPC member Alan Taylor to join outsider Swati Dhingra in calling for a rate cut, which would clear a 7-2 vote split.

In November, the only dissenter was Catherine Mann, who supported the holding rates while the other nine members of the committee voted to reduce them.

“Next year is about how the UK takes the budget transition,” said Matthew Amis, director of investment at abrdn. “If the private sector is able to pass on more costs to the consumer, that will be inflation and we are fighting to see the BOE cut three times.”

Amis said he is headed for a second scenario where private companies struggle to pass on additional costs and facilities to cut jobs. “At this point, we think the profile of a gradual rate cut seems unreasonable and the MPC should accelerate the pace of rate cuts in the first half,” he said.

The BOE is now falling behind both the European Central Bank, which has cut its interest rate four times since June to 3% from 4%, and the US Federal Reserve, which has cut it twice – including a large percentage point reduction in -September – to the range 4.5% -4.75%. The Fed may cut again in Dec. 18, the day before the BOE meeting.

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The different pace of devaluation caused fluctuations in currency markets. Earlier this week, the pound closed at its strongest level against the euro in more than eight years, while the yield spread between gilts and German peers edged closer in more than two years.

Nomura economist George Buckley said that would leave the BOE “between” the ECB, which is expanding rapidly as growth slows, and the Fed, which he expects will slow its cuts in March. Like most economists, Buckley believes the BOE will wait this month and cut by a quarter-point in February. “We’re seeing a policy divide,” he said.

Mike Riddell, portfolio manager at FIL Investment Management Ltd, said: “The BOE approach looks very similar to the Fed – but one of those economies is growing at around 3%, and the other is not growing at all.

—Courtesy of Tom Rees.

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