Interest rates ‘on path down’ despite hold at 5%, Bank of England chief says

The head of the Bank of England has indicated a willingness to start lowering interest rates again, even though borrowing costs remain steady at 5% as of Thursday. This comes in light of ongoing worries about persistent high inflation.

Andrew Bailey stated that the central bank is “slowly starting to reduce” its borrowing costs, which have been at levels not seen since before the 2008 financial crisis. “I believe that interest rates will decrease, and I’m hopeful about that,” he commented.

On Thursday, the monetary policy committee (MPC) of the Bank decided, with a vote of eight to one, not to proceed with consecutive cuts to interest rates, putting a hold on its attempts to lighten the financial burden on households.

Last month, the Bank lowered interest rates for the first time since the Covid pandemic began four years ago. This decision came after a significant drop in inflation, which had peaked above 11% in late 2022—the highest rate we've seen since the early 1980s.

Bailey mentioned that even though the pressures from inflation have been gradually decreasing, he wanted to warn people not to expect a quick change in monetary policy. "It's important for us to be cautious and avoid making cuts too quickly or too significantly,” he stated.

The yearly inflation rate stayed steady at 2.2% in August, slightly higher than the Bank's target of 2%.

The choice to maintain current interest rates was anticipated throughout the financial district. Following the Bank's announcement, the pound surged to its highest value against the dollar since March 2022, reaching $1.33.

On Wednesday, the US Federal Reserve lowered interest rates by 0.5%, marking the first decrease in four years. This change indicates that the dominant central bank is easing its previously forceful approach to managing inflation in the US economy. Similarly, the European Central Bank has also reduced interest rates on two occasions, each time by 0.25%, during separate policy meetings.

Many economists anticipate that the Bank will start lowering interest rates again in the coming months if inflationary pressures in the UK continue to decrease. Financial markets are already factoring in the likelihood of a further 0.25 percentage point cut in borrowing costs, bringing them to 4.75%, during the next policy meeting in November.

After reducing interest rates last month, the Monetary Policy Committee (MPC) reported that inflationary pressures have continued to decrease as anticipated. One committee member, independent economist Swati Dhingra, advocated for an additional quarter-point reduction in borrowing costs, opposing the majority of the nine-member panel.

Nonetheless, the Bank indicated that overall inflation is expected to climb to approximately 2.5% by the year's end, which is slightly lower than their forecast from August. This is due to steady price increases in the UK’s service industry and a competitive job market.

In the notes from its meeting, the MPC stated: "Monetary policy must stay restrictive for a considerable period until the threat of inflation consistently returning to the 2% target in the medium term has decreased significantly."

The central bank expressed worries about inflation exceeding the 2% target and announced that it would continue the practice of selling off government bonds that it accumulated during its quantitative easing program from the crisis period.

Threadneedle Street has announced plans to cut its holdings of UK government bonds by £100 billion over the coming year, targeting a total of £558 billion. At its highest point, the Bank owned as much as £895 billion in bonds, a strategy implemented to lower borrowing costs and ensure that markets operated smoothly during the 2008 financial crisis and the height of the Covid pandemic.

Chancellor Rachel Reeves is expected to keep a close eye on the situation leading up to next month's budget. There are rumors that she might modify the government's self-imposed fiscal guidelines to disregard the effects of the Bank's quantitative easing program.

Certain economists have proposed that this modification might create an extra financial space of roughly £20 billion.

Andrew Goodwin, the chief UK economist at the consultancy firm Oxford Economics, stated that even though the Bank has temporarily halted its series of interest rate reductions, it is likely to continue with them during the next Monetary Policy Committee meeting scheduled for November.

He mentioned, "We believe that another interest rate reduction is highly likely in November. Additionally, central banks around the world have noticeably shifted their approach lately, shifting their focus from strictly dealing with inflation to also taking economic growth issues into account."