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Cautious Bank of England hold rates, extends bond reduction plan

Published 09/19/2024, 07:04 AM
Updated 09/19/2024, 10:02 AM
© Reuters. A view of the Bank of England building, in London, Britain July 3, 2024. REUTERS/Maja Smiejkowska
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By Andy Bruce and David Milliken

LONDON (Reuters) -The Bank of England kept interest rates at 5.0% on Thursday, saying it would be careful about future cuts, and also held off from running down its bond holdings at a faster pace, avoiding extra budget strains for finance minister Rachel Reeves.

The Monetary Policy Committee voted 8-1 to keep rates on hold. Only external member Swati Dhingra voted for a further quarter-point rate cut after the BoE last month delivered its first reduction to borrowing costs since 2020.

Economists polled by Reuters had forecast a 7-2 vote for a hold after last month's tight 5-4 decision to cut rates from their previous 16-year high.

Sterling briefly jumped above $1.33 to its highest since March 2022 and investors scaled back bets on further rate cuts.

On Wednesday, the U.S. Federal Reserve cut rates by a larger than expected 0.5 percentage points, reflecting the Fed's confidence that inflation pressures are cooling.

BoE Governor Andrew Bailey struck a more cautious tone as wage growth looked set to remain too high for comfort and policymakers remained divided over how fast longer-term inflation pressures were fading.

"It's vital that inflation stays low, so we need to be careful not to cut too fast or by too much," he said.

Bailey later told broadcasters he was "optimistic" rates would fall further, but that the BoE first needed more evidence of cooling price pressures.

Investors think the BoE will cut rates more slowly than the Fed.

"Underlying inflation pressures in the UK remain elevated, while the labour market is sending quite mixed messages about the health of the economy," said Luke Bartholomew, Deputy Chief Economist at fund manager abrdn.

The BoE said inflation was likely to accelerate to around 2.5% by year-end from 2.2% in the most recent data, a smaller increase than its forecast last month for a rate of around 2.75%. Lower oil prices contributed to the change.

BoE staff also estimated that unemployment had probably risen more in recent quarters than suggested by official data, which has suffered from very low response rates, but the MPC judged that the labour market remained tight overall.

After Thursday's announcement, investors no longer fully priced in two rate cuts by the end of 2024, but expected the BoE to cut rates in quarter-point steps four or five more times by June. By contrast, they see around seven such cuts in the U.S. 

QT CONTINUES

The MPC voted unanimously to reduce its government bond holdings by a further 100 billion pounds between October 2024 and September 2025, matching the reduction it undertook over the past 12 months.

The BoE bought 875 billion pounds of gilts between 2009 and 2022 under its quantitative easing programme to stimulate the economy. The newly announced round of quantitative tightening (QT) will lower this to 558 billion pounds.

Some investors had predicted an acceleration of QT, as the BoE holds 87 billion pounds of gilts that are due to mature naturally over the next year, leaving just 13 billion pounds for active gilt sales at the current pace.

Lawmakers and think tanks have criticised QT because it brings forward losses sustained by the BoE, which purchased gilts in past years at much higher prices than their current sale value. Those losses are underwritten by the taxpayer.

The BoE also makes losses from paying interest on the reserves it issued to finance the purchases of gilts. With Bank Rate at 5%, those interest payments now outstrip the returns generated by the bonds by a wide margin.

Many economists think finance minister Rachel Reeves  will change Britain's fiscal rules to exclude the impact from QT in her inaugural budget on Oct. 30 - something that could give her several billion pounds of extra fiscal space.

Bailey said he had no concerns about this, and that fiscal considerations did not influence the BoE's QT decisions.

© Reuters. A view of the Bank of England building, in London, Britain July 3, 2024. REUTERS/Maja Smiejkowska

James Sproule, UK chief economist at Swedish bank Handelsbanken, said the lower level of active sales compared with the previous year would help Reeves as it would reduce compensation due to the BoE.

($1 = 0.7515 pounds)

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