Bank of England Keeps Interest Rates Steady

By Andy Bruce and David Milliken

LONDON (Reuters) – The Bank of England kept interest rates at 5.0% on Thursday, indicating caution about future cuts and avoiding faster reductions in its bond holdings, which would strain finance minister Rachel Reeves’ budget.

The Monetary Policy Committee voted 8-1 to maintain rates. Only external member Swati Dhingra pushed for a further quarter-point cut after last month’s first reduction to borrowing costs since 2020.

Economists surveyed by Reuters anticipated a 7-2 vote to hold rates after the prior month’s narrow 5-4 decision to cut rates from a 16-year high.

Following the announcement, the British pound climbed briefly above $1.33, its peak since March 2022, as investors reduced expectations for further rate cuts.

This comes after the U.S. Federal Reserve unexpectedly cut rates by 0.5 percentage points, indicating confidence that inflation pressures are easing.

BoE Governor Andrew Bailey expressed caution, highlighting persistent wage growth and divided viewpoints amongst policymakers regarding the pace at which long-term inflation pressures are subsiding.

“It’s vital that inflation stays low, so we need to be careful not to cut too fast or by too much,” he stated.

Bailey later expressed optimism about future rate reductions, though he emphasized the need for more evidence of decreasing price pressures.

Investors anticipate the BoE will lower rates more gradually than the Fed. Luke Bartholomew, Deputy Chief Economist at abrdn, noted that the UK’s underlying inflation pressures remain significant, with mixed signals from the labor market regarding economic health.

The BoE projected inflation might rise to about 2.5% by year-end from the prior 2.2%, a decrease from last month’s forecast of around 2.75%, partly due to lower oil prices.

BoE staff estimated that unemployment might have increased more than official data suggests, but the MPC still deemed the labor market tight overall.

Investors now expect the BoE to implement four to five additional quarter-point cuts by June 2024, a sharp contrast to around seven anticipated cuts in the U.S.

Quantitative Tightening Continues

The MPC unanimously agreed to reduce its government bond holdings by an additional £100 billion from October 2024 to September 2025, mirroring last year’s reduction.

The BoE had purchased £875 billion of gilts from 2009 to 2022 as part of its quantitative easing program to stimulate the economy. The current round of quantitative tightening (QT) will lower holdings to £558 billion.

Some investors had anticipated a quicker QT, given that the BoE has £87 billion of gilts maturing over the next year, leaving only £13 billion for active sales at the present pace.

Critics, including lawmakers and think tanks, have expressed concerns about QT, arguing it incurs losses that taxpayers will underwrite due to the BoE purchasing gilts at significantly higher prices than their current values. The BoE also incurs losses from interest paid on reserves used for gilts financing, with interest now exceeding returns from the bonds.

Many economists predict that finance minister Rachel Reeves will adjust Britain’s fiscal rules to exclude QT impacts in her first budget on Oct. 30, potentially providing her with billions in additional fiscal space.

Bailey dismissed concerns regarding this change, affirming that fiscal factors did not sway the BoE’s QT decisions.

James Sproule, chief economist at Handelsbanken, noted that the reduced active sales compared to the previous year would benefit Reeves by decreasing the compensation owed to the BoE.

($1 = £0.7515)