03 November 2023
Today’s decision to hold interest rates at 5.25% again confirms that rates have peaked, although the committee emphasised that it will restart tightening if needed – we don’t think it will. Attention will now inevitably turn to when interest rates will start to be cut. However, inflation is likely to remain sticky over the next year, meaning rates will remain around their current levels until Q3 next year and even then rates are only likely to come down gradually.
Interest rates on an extended pause
The Monetary Policy Committee (MPC) chose to hold its benchmark rate at 5.25%, in line with our view and the consensus expectation. The vote split was 6-3. As expected, there was no dovish shift in the guidance. It continued to indicate that policy is considered restrictive and will remain that way for some time.
However, The MPC has gone out of its way to signal that it does not expect to reduce Bank Rate next year. The committee has added to its key guidance paragraph that its “latest projections indicate that monetary policy is likely to need to be restrictive for an extended Bank of England period of time”. This is simply the MPC trying to reinforce the message that is not expecting to cut interest rates anytime soon. Indeed, Governor Bailey also said in the press conference that “it is much too early to be thinking about rate cuts”.
Another year of stagnation
The fall in interest rate expectations since the last forecast round in August means the MPC’s new forecast is conditioned on an interest rate path about 0.5 percentage points (ppts) lower than previously. However, despite the lower path for interest rates the Bank downgraded its economic forecasts for next year from 0.5% growth to flat growth. So, the MPC isn’t technically forecasting a recession but it’s as close as one can get without a negative number.
What’s more, the Bank revised its forecast for the unemployment rate significantly higher (5% to 5.5%), indicating that there is more pain in store for the labour market.
At the same time, inflation in three years’ time is now seen undershooting the 2% target by a smaller margin than in August (1.7% vs 1.5%). However, the forecast based on constant rates shows inflation falling to 1.4% – the implication being that the MPC thinks it will be able to cut rates at some point in the next three years.
With inflation and wage growth still far too high for the MPC to be comfortable it makes sense for the Bank to talk tough. Inflation should take a big step down, to below 5%, in October which should remove much of the pressure for the MPC to resume its tightening cycle. What’s more, the labour market already has loosened considerably—the unemployment rate now matches the MPC’s estimate of its equilibrium rate—and the timeliest evidence points to a further loosening to come. That should drag wage growth down.
Overall, the MPC is saying that the UK economy is in for another year of stagnation and even though it’s not forecasting a recession, one is perilously close. What’s more, interest rates are unlikely to have to go any higher. However, cuts are not imminent.
That is very much in line with our own forecast. Indeed, we estimate that only a little over half of the full impact from the previous rise in interest rates has come through to the real economy so far. That means there is still a big drag on the economy to come. And as inflation falls, real interest rates will rise, increasing the drag on the economy without the MPC having to raise rates further. We aren’t forecasting a recession, but with precious little growth over the next year it wouldn’t take much to tip the economy into one. As a result, we think patience was the correct decision from the MPC and that interest cuts won’t come until Q3 next year.