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BOE and Markets Fall Into Line Over Prospect of June Rate Cut - BLOOMBERG

MAY 09, 2024

BY  Philip Aldrick and Greg RitchieBloomberg News

, Source: Statistics agencies

(Bloomberg) -- After months in which the Bank of England and markets have been at loggerheads over the direction of interest rates — with the US Federal Reserve more powerful in shaping expectations than words from the UK central bank — they have now fallen roughly into line.

A quarter point reduction in Britain’s benchmark lending rate to 5% “is neither ruled out nor a fait accompli,” Governor Andrew Bailey told reporters after making no change on Thursday. He added that reductions are likely “over the coming quarters.” 

The remarks left investors betting on an even chance of the first rate cut since the pandemic arriving in June, with near certainty in August. It marks a big shift in market expectations over recent weeks, when investors ratcheted back bets on rapid cuts for the UK after stronger inflation in the US. It’s a victory for Bailey, who has been at pains to point out that the UK is closer tracking the eurozone, where cuts are due next month, than the US.

“The door is wide open for a cut at the next meeting if inflation and wage pressures evolve favorably over coming weeks,” said Henry Cook, senior economist at MUFG EMEA. “There will be extra market scrutiny on the upcoming CPI and wage releases.”

Getting the markets on the same page as the BOE is also vital for Chancellor of the Exchequer Jeremy Hunt, who is hoping lower rates give the Conservative party a political boost as the country heads into an election before the end of the year. Hunt has claimed rate cuts would deliver the country a “feel-good factor,” which the government needs after last week’s rout in local elections.

Bailey has now maneuvered investors into focusing more closely on UK economic data to guide their outlook for rates. With two sets of inflation and labor market releases due before the next vote on June 20, everything now hinges on how the UK economy evolves.

The BOE has had to wrest back control of the market path from the powerful pull of the US this year. At the start of 2024, the BOE was still hawkish – driven by what appeared to be sticky underlying inflation. Three members of the nine-strong monetary policy committee were voting for rate rises and the BOE, was signaling that it might still have to ratchet policy tighter again.

Despite that, expectations that the Fed would ease imported into the UK market curve a steep series of cuts — four in total over 2024 and further drop to 3.25% in 2026. In February, the BOE leaned into that by endorsing the path in its forecast. That helped a pivot to a more dovish tone, with Bailey ruling out further hikes. 

In March, the final two hawks abandoned their call for higher rates. Now Deputy Governor Dave Ramsden has joined Swati Dhingra in seeking an immediate easing. Those moves are the clearest sign yet that the BOE, which was in tightening mode just four months ago, now is clearly planning to loosen policy.

During that time, the US has more clearly drifted away from the UK. Higher-than-expected US inflation data reversed the Fed’s narrative, leaving Chair Jerome Powell warning rates may remain elevated there a little longer. 

What Bloomberg Economics Says ...

“The Bank of England remains on course to ease in June following its May decision. Another dissenting vote for a cut, a guidance tweak emphasizing the near-term data flow and a forecast that pushes back on market pricing, all suggest the central bank is increasingly confident it can loosen policy soon. We think it will have the evidence needed to cut by its next meeting.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.

In recent weeks, the UK markets have followed the US lead, betting on fewer cuts from the BOE. That triggered an intervention from Bailey in Washington last month, when he noted that the factors driving the UK and US economies are sharply different. His remarks on Thursday completed Bailey’s pivot.

“It’s certainly true when our staff do the analysis that market movements of late – in recent months – have been dominated by movements in the US coming over to other markets including our own,” Bailey told a press conference Thursday. “To my mind the inflation dynamics in the UK are different to the US. It’s important to make that distinction. We’ve seen some response in markets to that of late, where there has been some decoupling. But it is a question that we have to keep posing.”

The pull of the US is more than a market dynamic, it has real economy effects in Britain. Mortgage and other borrowing costs are determined by market rates, which is why some home loan deals have been getting more expensive recently despite the BOE’s dovish shift. Bailey made another rare intervention in markets on Thursday, saying policy needed to be less restrictive “possibly more so than currently priced into market rates.”

He later told Bloomberg TV there was a “high bar” to making such statements. The implication may be that more than the two cuts forecast for this year before the decision are needed — or that, in the longer term, rates need to drop below the 3.75% currently projected.

The scale and timing of rate cuts is important for For Prime Minister Rishi Sunak’s government, due to call an election later this year. The BOE upgraded growth forecasts for 2024, 2025 and 2026 and now expects a big increase this year in real household disposable incomes, a measure of living standards. That could well deliver the “feel-good factor” Hunt wishes for.

Wages will rise more strongly than previously thought in 2024, as inflation comes back to the 2% target, giving the average household a 3% increase in real-terms pay. Consumption growth will “pick up” because people feel richer as energy bills fall in April. 

There is even evidence of “improved sentiment” in the housing market, with prices will also due to “pick up in the months ahead.” Hunt’s tax cuts got the BOE’s seal of approval, too. It said they add 0.25% to the level of GDP.

Whether the BOE delivers the June rate cut Hunt — and the rest of the country — desires now depends on how the data evolves.

“There’s a delicate balance to be struck between managing inflationary pressures and not snuffing out a nascent recovery,” said Anna Leach, deputy chief economist at the CBI, Britain’s biggest business lobby group. “The first rate cut is most likely to be in August.”

--With assistance from Andrew Atkinson and Tom Rees.


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