People walking past the Bank of England in London. — AP
LONDON: The Bank of England (BoE) is being urged to end its bias toward further interest-rate hikes or risk undermining its own credibility, in what’s likely to be a tricky communication challenge for governor Andrew Bailey.
Former members of the central bank’s Monetary Policy Committee (MPC) and other senior British economists said the BoE’s current hawkish stance is out of step with both the economic outlook and peers in the United States and the eurozone.
New guidance, they said, should come with the next rate decision on Feb 1.
The longer the BoE waits, the more it risks clashing with a general election Prime Minister Rishi Sunak is expected to call later in the year.
The BoE’s current guidance hasn’t changed since August, when the latest inflation reading was 7.9% and the MPC raised rates for a final time to 5.25%.
As recently as last month, three of the nine MPC members voted to increase borrowing costs, and Bailey said there was “some way to go” in the fight against inflation.
Since then, output, wages and job creation have all weakened. Inflation has fallen to 4% and is on track to hit the 2% target by spring, a year earlier than the BoE’s most recent forecast.
Both the US Federal Reserve (Fed) and European Central Bank (ECB) have signalled rate cuts are on the agenda.
Investors have barrelled ahead of the BoE, pricing in sharp rate cuts this year and posing a new threat to bank’s credibility.
Public confidence in the institution is already at a record low.
The BoE “is still very hawkish”, Jari Stehn, economist at Goldman Sachs, said at a conference on Jan 15. As a result, switching the message will “take a little bit longer” for the BoE than the Fed or ECB, he added.
Markets are betting on a sharp reduction in borrowing costs this year, even after the slight shift in sentiment following last week’s surprisingly strong inflation reading in Britain.
They’ve priced in four quarter-point cuts in the benchmark rate to 4.25% this year, starting in June. Just three months ago, markets saw rates remaining above 5% throughout 2024.
How far out of step the BoE has become with its peers was driven home last week when ECB president Christine Lagarde told Bloomberg TV that a rate cut for the euro area was likely by summer.
Meanwhile, Fed chairman Jerome Powell has said rates should be reduced before inflation drops to 2%, which Goldman Sachs chief economist Jan Hatzius said was consistent with “cuts at the March meeting”.
Yet the BoE said in December that policy was “likely to need to be restrictive for an extended period of time” and that “further tightening” might be necessary. That month, three MPC members voted to raise rates a quarter point, and none backed a rate cut.
Bailey will need to avoid making its former guidance look like nonsense when the bank eventually pivots.
George Buckley, chief European economist at Nomura, said the MPC’s current view should be toned down.
“It would make a lot of sense to change the guidance from ‘further tightening’,” he said.
Michael Saunders, a former BoE rate-setter who is now senior policy adviser at Oxford Economics, said the bank could use its forecast to soften the guidance by showing that “unchanged rates would leave inflation well below target two and three years out, while the market curve would be about right”.
Another way the bank could signal a shift would be for individual MPC members to cast more dovish votes. The February vote could split three ways, Buckley said. In that scenario. one or two MPC members vote for a hike, one for a cut and six or seven for hold.
Politics may complicate BoE policy on two fronts. The chancellor will deliver a budget in March, and any broad-based tax cuts announced then could add to inflation, delaying rate cuts.
Also, an early election might paralyse decision-making, with policy makers wanting to move carefully to avoid their decisions looking political.
While a general election is widely expected to be held around November, an earlier vote would run a greater risk of clashing with the BoE’s first cut.
In the six elections since the government established the bank’s independence in 1997, it has moved policy only once during a campaign: a quarter-point cut in 2001, two days after the election was called.
Saunders said MPC members “might be reluctant to make the first cut during a campaign,” but would they be less concerned if the loosening process had begun.
BoE deputy governor Ben Broadbent has indicated that uncertainty would leave the bank in limbo, a comment that would apply to potential change in government.
“The reaction of policy is likely to be somewhat more delayed,” he said in December.
Conversely, the government’s stated ambition to cut taxes in the March budget may tempt the BoE to wait before cutting rates, said James Smith, market economist at ING Groep NV. — Bloomberg
