Stubborn Inflation Means No Pivot at the BOE

Bank of England (BoE) is maintaining a hawkish stance on interest rates despite the US Federal Reserve signaling rate cuts in the new year. BoE Governor Andrew Bailey and colleagues held rates at 5.25% and downplayed positive signs in the UK economy. BoE remains concerned about underestimating inflation and wants to avoid domestic criticism. UK wage growth is higher than in the US and the euro area, indicating a tighter labor market. BoE warns that rates could rise but also acknowledges that the decision is finely balanced.

The central bank’s decision to maintain its hawkish stance on interest rates comes amidst a backdrop of uncertainty surroundin the UK economy. The country’s labor market remains robust with wage growth outpacing that of its international counterparts. In short, inflation is more stubborn in the UK compared to the US and Europe at the moment.

However, some economists argue that the BoE’s reluctance to adopt a more accommodative stance may be influenced by political considerations. With domestic criticism already looming over the bank’s handling of monetary policy, any perceived deviation from a hawkish stance may further fuel public discontent.

The decision to hold rates steady certainly has its trade-offs. On one hand, it helps to anchor inflation expectations and provides a sense of stability for businesses and consumers. On the other hand, it may hinder economic growth by restricting borrowing and investment. This is of a particular concern in the UK, due to the structure of the mortgage market. In short, fixed-rate mortgages are only for 2 to 5 years, with rates resetting. Facing higher mortgage costs hurts the consumer and slows down economic activity.

The key points are as follows:

• The Bank of England (BoE) kept interest rates steady at 5.25%.
• BoE Governor Andrew Bailey warned that there is still a long way to go before inflation hits the target of 2%.
• The BoE’s Monetary Policy Committee (MPC) said that interest rates would need to be kept high for an extended period of time, but left open the option for rate rises if necessary.
• BoE staff expect UK GDP to be flat in the fourth quarter, with household spending weaker than previously expected.
• The MPC decision to keep rates unchanged was finely balanced, with three members voting for an extra quarter-point rate increase.
• The BoE noted that consumer price inflation had fallen, but core inflation remained higher and wage growth was elevated.