When will UK rates start to fall?

Two years after it began climbing the rate-hiking trail, the Bank of England (BoE) on Thursday finally whispered that it’s thinking about heading back home.

The BoE is uncomfortable being on top of Table Mountain for too long, but it’ll only start the descent when services and wage inflation moderate.

Overall, the bank’s comments indicated future rate cuts may be at the more cautious end of our expectations, and may not begin until the next big tranche of inflation numbers arrives.

Treading carefully

Instead of cheerleading the fact that headline inflation will fall to its 2% target in the spring, the BoE warned this was ‘temporary’ and focused on ‘ex-energy’ and services inflation. It’s in no rush to claim victory in the inflation fight. This suggests it will cut step by step as data confirm it’s on the right path.

Wage inflation is one area where the data is moving in the right direction, but not fast enough to send the bank bounding down the mountain. The BoE’s agents suggest pay settlements will be 5.4% this year, which is only down slightly from 6% last year and higher than the long-term average of 3¼%.¹ Hikes in the national living wage were cited. However, agents also said companies will find it harder to pass on costs this year than last, so the bank will want confirmation of that in key services data.

The Bank explained that data doesn’t need to improve all the way to target-consistent levels before they cut rates. They don’t want to leave rate cuts too late. Low headline inflation this year should depress pay settlements in 2025. But it seemed happy to cut rates before next year’s pay deals are announced so long as the overall outlook remains benign.

An improving growth outlook argues against aggressive near-term cuts. While the agents survey suggested activity remains weak in the near term, optimism about the future had improved. In particular, most contacts said they intend to maintain employment at current levels, with fewer reports of planned headcount reductions. This reduces the risk of a self-reinforcing ‘paradox of thrift’ spiral developing and reinforces the improvement in credit conditions highlighted in the latest survey.

Are we nearly there yet?

We forecast May/June for the start of cuts, and 75-100 basis points (bps) of cuts this year, with uncertainty about magnitude and timing. Markets are, at the time of writing, pricing in marginally more. It's worth highlighting, however, that markets don't imply a great deal about what's actually delivered in terms of rate cuts or hikes.

The BoE’s focus on ‘ex-energy’ rather than headline inflation argues for the more cautious bound of our forecasts, even though we see a sharper fall in energy prices.

The next Inflation Report press conference will be on 9 May, which will be followed on the 22 May by the April inflation data. Given many services prices are reset once a year, this will be a key signpost for the BoE.

Those holding their breath for interest rate cuts in May might be left disappointed.

1. Source: Monetary Policy Report - February 2024 | Bank of England