The Bank of England (BoE) on Thursday held its key interest rate at a 16-year high of 5.25% ahead of a July 4 election, even though inflation has fallen to its target of 2%, with several policymakers warning that a premature cut could stoke another bout of price rises.
Seven of the nine members of the bank’s policymaking Monetary Policy Committee (MPC) voted for no change while two backed a rate cut. The vote was consistent with that seen at the bank’s meeting last month. Interest rates have been unchanged since August after a series of hikes.
It was clear in the statement accompanying the decision that there was a divergence of opinion over the outlook for inflation, with some clearly concerned over still-high price rises in the services sector, the primary motor of the British economy.
“It’s good news that inflation has returned to our 2% target,” said Bank of England Governor Andrew Bailey. “We need to be sure that inflation will stay low and that’s why we’ve decided to hold rates at 5.25% for now.”
Bailey’s statement differed from last month, when he said he was “optimistic” that data was moving in the right direction for a rate cut.
The sterling fell against the U.S. dollar after the announcement and British government bond yields dropped as investors saw a greater chance of an early rate cut.
The decision is likely to disappoint the governing Conservative Party ahead of the U.K.’s general election in two weeks time. A cut would have been seized upon by Prime Minister Rishi Sunak as positive economic news, especially as it would have been accompanied by a fall in mortgage rates.
The panel insisted that the imminent election, which the main opposition Labour Party led by Keir Starmer is widely expected to win, had no bearing on its decision. It said the decision was, as always, based on achieving the 2% inflation target “sustainably in the medium term.”
Economists believe that a cut is imminent, either at the bank’s next policymaking meeting in August or the following one in September. They expect there will be clear evidence by then that inflation is set to remain around the target over the coming year or two.
“We continue to think that the MPC will start dialling down restrictive policy from summer and deliver two rate cuts this year,” said Sanjay Raja, chief U.K. economist at Deutsche Bank.
“We still expect the MPC to cut rates in August but this is not a done deal – they remain very data-driven so the evolution of key indicators over the coming month will be key,” said Alpesh Paleja, interim deputy chief economist at the Confederation of British Industry.
Too late for Sunak?
Any cut is likely to be too late for Sunak, whose Conservative Party is around 20 points behind the Labour Party in the pre-election polls.
While Sunak has sought credit for the fall in inflation since he took office in October 2022, when it was at a 41-year high of 11.1%, Labour blames high mortgage rates on economic mismanagement by the Conservatives’ previous leader, Liz Truss.
The BoE said the upcoming election had no impact on its decision.
The decline in the main inflation measure to 2% in the year to May does not mean that prices are falling – they are just rising at a slower rate than they have for the past few years during a cost of living crisis that has seen living standards drop for millions across Britain.
The fall in inflation follows nearly three years of above-target inflation, which prompted central banks around the world to dramatically increase borrowing costs from the lows seen during the coronavirus pandemic.
The last time inflation in the U.K. was at 2% was in July 2021 before prices started to shoot up, first as a result of supply chain issues during the pandemic and then because of Russia’s invasion of Ukraine, which pushed up energy costs.
Higher interest rates – which cool the economy by making it more expensive to borrow – have helped ease inflation, but they’ve also weighed on the British economy, which has barely grown since the pandemic rebound.
Critics of the Bank of England say it is being overly cautious about inflation and that keeping interest rates too high for too long will unnecessarily weigh on the economy.
Some central banks, including the European Central Bank (ECB), have started to cut rates as inflationary pressures have eased. The Swiss National Bank on Thursday reduced its main rates by a quarter of a percentage point to 1.25%.
On the other hand, financial markets do not expect the U.S. Federal Reserve (Fed) to lower borrowing costs until late this year.
