(Commonwealth) _ In its May meeting, the Bank of England (BoE) decided to maintain the bank rate at 5.25%, a move that aligns with market expectations and underscores the Bank’s commitment to a restrictive monetary policy aimed at reducing inflation to its 2% target over the medium term. The decision, however, was not unanimous. Monetary Policy Committee members Swati Dhingra and Dave Ramsden advocated for a 0.25 percentage point reduction, suggesting a rate of 5%. This split decision marks a departure from previous meetings, where dissent typically came from only one member.
Despite the steady decline in inflation, which recently fell to 3.2% year-over-year, the cost of borrowing in the UK remains significantly high, standing 2 percentage points above the inflation rate. Bank of England Governor Andrew Bailey commented, “We are not yet at a point where we can cut the base rate.” He also noted the potential for a June rate cut, depending on the outcomes of the upcoming inflation reports.
Regarding the broader economic outlook, the BoE projects the UK’s gross domestic product (GDP) to grow by 0.4% in the first quarter of 2024 and by 0.2% in the second quarter. For the entire year, growth is anticipated to be 0.5%, with projections of 1% and 1.25% for 2025 and 2026, respectively. These figures represent a modest improvement from earlier forecasts, suggesting cautious optimism about the UK’s economic recovery.
However, the Bank warned of emerging economic slack in 2024 and 2025, implying that the economy may underperform its potential output. This slack is expected as a consequence of the ongoing restrictive monetary policy, which could dampen economic activity more broadly.
Labour market conditions have recently loosened, with indicators showing easing pay growth. Nonetheless, the BoE still considers the overall job market tighter than historical norms. The unemployment rate is forecasted to rise slightly from 4.4% in the fourth quarter of 2024 to 4.8% by the end of 2026.
On the inflation front, the Bank of England highlighted that headline consumer price inflation has continued to decline. However, service sector inflation remains high at 6.0% as of March. Governor Bailey pointed out that “higher than expected wage and services inflation since February should give us pause for thought, but shouldn’t be overinterpreted.”
Consumer inflation is projected to approach the 2% target in the near term but could edge up later in the year due to the unwinding of energy-related base effects. Notably, the BoE’s new projections now see the annual inflation rate falling to 1.9% in two years’ time and 1.6% in three years, thus falling below the 2% target.
Looking ahead, the BoE’s future decisions will hinge on incoming data, particularly indicators of inflation persistence and economic resilience. This includes closely monitoring labour market tightness, wage trends, and service price inflation. The central bank remains data-dependent, indicating that rate adjustments could be considered should economic conditions change significantly.
Market reactions to the BoE’s decision were immediate. The British pound weakened against major currencies, with the pound-dollar exchange rate easing to 1.2470 from 1.25. The euro also gained strength against the pound, rising to 0.8615. The 2-year gilt yield, a key indicator of interest rate expectations, declined slightly to 4.29%, reflecting rising expectations of a potential rate cut by the BoE in the near future.
Equity markets responded positively, with the FTSE 100 index climbing 0.6%, marking its sixth straight session of gains, the longest streak since late January. Top gainers included BP (up 1.5%), Reckitt Benckiser (up 1.4%), and Frasers Group (up 1.4%). Conversely, laggards were 3i (down 4.1%) and HSBC Holdings (down 3.7%).
