What did the Bank of England say about UK base rates?

The recent announcement that UK base rates will remain unchanged was no surprise to the market. However, the genuinely positive upbeat statement from Andrew Bailey, the governor of the Bank of England, did surprise many. So, what did we learn about the future direction of UK base rates?

 

Multiple interest rate reductions likely later this year

 

Andrew Bailey’s strongly indication of multiple interest rate cuts later this year was well received by the market. Not only has the Bank of England managed to control inflation, with is now down to 3.4%, but it has also managed to avoid what were described as “second-round effects”, i.e. major wage inflation.

 

Global shocks are subsiding

 

In recent years, we have seen a range of global shocks that have significantly increased global inflation and supply chain issues. While new challenges can quickly emerge, the ongoing issues are not having a significant impact on inflation. Consequently, central banks across the globe are now more optimistic about interest rate reductions for more than a decade.

 

Is the UK recession over?

 

Towards the end of 2023, the UK entered what was described as a "light" technical recession, which the Bank of England viewed as a short-term challenge. There are signs of improvement in the UK economy, and the Bank of England suggested that the recession may already be over. As we await the next quarterly data, there are growing hopes that the UK economy is back in positive territory.

 

What about the Bank of England’s 2% target inflation rate?

 

There had been concerns that the Bank of England would only move on interest rates when inflation hit the long-term target rate. However, recent statements from Andrew Bailey suggest that the bank is more interested in the "trajectory" to the target rate than waiting until inflation hits 2% before reducing interest rates. While this doesn't give us a definitive timescale on interest rate reductions, it does suggest that a move is not too far away.

 

Could we see the first interest rate reduction in June?

 

Looking a number of weeks ahead, never mind months, is challenging in the world of economics. Still, in a rare moment of clarity, Andrew Bailey said he appreciated market expectations for a decrease in interest rates as early as June. If this is not an indicator that the bank is thinking in line with the markets, there could be significant disappointment if we don't see a reduction in June.

 

Has the Bank of England recognised mistakes were made?

 

Interestingly, while markets have been critical of the Bank of England's approach to inflation, reacting too slowly to the initial rise and taking a more conservative approach on the way down, changes may be afoot. The bank has already confirmed it is reconsidering its approach to forecasting and communications to the marketplace. Might we move away from traditional fan chart forecasts to alternative economic scenarios?

 

This type of change seems to be led by Ben Bernanke, the former chair of the Federal Reserve, who appears to favour a "dot plot" system for interest rate expectations. While the Bank of England has attracted its fair share of criticism recently, many other central banks have also been accused of varying degrees of mismanagement of monetary policy.

 

Interestingly, the Bank of England has also announced plans to adopt a more open culture where staff will be encouraged to challenge senior officials on monetary policy. Quite how this will work in practice remains to be seen, but this is further acceptance that change is needed.

 

Conclusion

 

The consensus was that UK base rates would remain unchanged, but for many, it was the very positive statement from the Bank of England that caught them by surprise. Interest rates will likely start to fall in June this year, in line with other central banks, although there was a cautionary note about the need to keep a close eye on wage inflation, which is not showing signs of huge strength.

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