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Projected UK Interest Rates in 5 Years: Slowing Inflation Not Enough For BoE Cut

Last Updated June 20, 2024 1:54 PM
Giuseppe Ciccomascolo
Last Updated June 20, 2024 1:54 PM
Key Takeaways
  • The Bank of England paused rate hikes for the seventh consecutive time in June.
  • Two members of the monetary policy committee voted to cut rates.
  • The BoE decided to keep the policy unchanged despite the inflation hit its target in May.
  • Rates play a fundamental role in tackling high inflation.
  • How do interest rates influence cryptocurrencies?

At its June meeting, the Bank of England maintained  interest rates at a 15-year high, marking the seventh consecutive meeting without a change. However, a notable shift in the voting makeup  occurred, with two members of the Monetary Policy Committee voting to cut rates.

The bank decided to not follow the European Central Bank – which cut its rates last week – despite the UK inflation hit the BoE target of 2% in May. The next decision is scheduled for August.

No Change In June

Seven members of the MPC, voted to keep interest rates unchanged. Meanwhile, two members, Swati Dhingra and Dave Ramsden, favored reducing the bank rate by 0.25 percentage points to 5%.

The BoE mentioned  that the restrictive stance of monetary policy is “weighing” on real economic activity, leading to a more relaxed labor market and suppressing inflationary pressures.

The BoE further stated: “Indicators of short-term inflation expectations have also continued to moderate, particularly for households. CPI inflation is expected to rise slightly in the second half of this year, as declines in energy prices last year fall out of the annual comparison.”

They added: “Key indicators of inflation persistence have continued to moderate, although they remain elevated.”

The BoE emphasized that monetary policy will need to remain restrictive for “sufficiently long” to ensure inflation sustainably returns to the 2% target in the medium term.

“The Committee has judged since last autumn that monetary policy needs to be restrictive for an extended period of time until the risk of inflation becoming embedded above the 2% target dissipates,” they added.

The MPC noted that the timing of the general election on July 4 did not influence its decision in this meeting.

Slowing Inflation Not Enough For A Cut

Regarding the decline in inflation to 2%, the MPC noted that while some members welcomed this development, it did not necessarily indicate a sustained return to the target level.

Laura Suter, director of personal finance at AJ Bell , told CCN: “The chances of a rate cut were already very slim, but market hopes fell even further after yesterday’s inflation figures. Much of the public might have expected that once we hit the coveted 2% target for inflation the Bank would immediately start cutting rates. Sadly, that’s not the case. Sticky core inflation and higher services inflation all helped to play into the Bank’s decision not to cut rates.

“On top of that, the Bank has taken a vow of silence during the general election campaign – meaning that if it did cut interest rates it wouldn’t have been able to explain the decision. We know from previous Base Rate moves that the comments the Bank makes are almost as significant as the interest rate move itself.

“The other elephant in the room is the outcome of the general election. Whoever makes it into Number 10 will be changing policy, taxes and the fortunes of the UK economy, all of which play into the economic data the Bank scrutinises every month. The MPC will likely want to examine any plans and the impact on inflation and other data before it makes the move to cut rates. If they are victorious, Labour have pledged an economic update in September – which casts some doubt on an August interest rate cut, as the Bank may decide to wait and see the outcome of that update before getting its axe out to cut rates.”

Open Door For Summer Cut

Following the May decision, BoE Governor Andrew Bailey emphasized  that the conditions for a bank rate cut had not yet fully materialized.

Bailey highlighted the importance of upcoming data releases in determining the appropriate duration for maintaining the current rate level. He indicated the likelihood of rate cuts over the next few quarters, potentially exceeding market expectations, but cautioned against assuming a definitive outcome for a June cut.

Acknowledging the inherent fluctuations in economic data, Bailey underscored the significance of additional data points in guiding the BoE’s decision-making process. With two inflation readings preceding the June rate decision, Bailey expressed confidence in the BoE’s ability to gauge the timing for adjusting its policy stance.

Bailey also emphasized the potential for second-round inflation effects to dissipate sooner than previously anticipated, highlighting differences in inflation dynamics between the UK and the US.

In its updated guidance, the BoE introduced a section emphasizing the consideration of forthcoming data releases in assessing the diminishing risks associated with inflation persistence.

The BoE’s latest forecasts indicate a return of consumer price inflation to near the 2% target in the short term, with a slight uptick expected in the latter half of the year due to energy-related base effects. Consumer price inflation is projected to reach 1.9% in two years and 1.6% in three years, as per the May report.

A conference wasn’t held on June 20, 2024, as the BoE members cannot participate to public events days before the elections in the UK.

Economic Data Slightly Improved

The central bank noted the ongoing effects of tighter monetary policy on the labor market and the overall momentum in the real economy. It said : “With a significant increase in the bank rate during this tightening cycle, the current monetary policy stance is deemed restrictive.

“The Monetary Policy Committee (MPC) will maintain a vigilant watch on signs of persistent inflationary pressures and the resilience of the economy as a whole.

“This includes assessing various factors such as labor market conditions, wage growth, and service price inflation. The aim is to maintain a sufficiently restrictive monetary policy for an extended period, ensuring a sustainable return of inflation to the 2% target over the medium term.”

The Bank of England also presented its latest monetary policy report, which outlines its economic outlook for the UK.

UK inflation rate over the years
UK inflation reached its peak after the post-pandemic period.

GDP Tops Estimates In March And Q1

Official numbers  released on Friday, May 10, 2024 indicate stronger-than-expected growth for the UK economy in March and the first quarter of 2024.

In March, UK gross domestic product (GDP) saw a 0.4% increase from February, surpassing market expectations of 0.1% growth. Revised data  from the Office for National Statistics (ONS) showed a 0.2% expansion in February.

For the first quarter of 2024, GDP is estimated to have grown by 0.6%, exceeding expectations of a 0.4% increase. This follows a 0.3% decline in the fourth quarter of 2023 and a 0.1% decline in the third quarter. Compared to the same quarter a year ago, GDP rose by 0.2%.

Additionally, industrial production  rose by 0.2% in March from February, contrary to expectations of a 0.5% decline. February had seen a 1.0% increase from January. On an annual basis, industrial production improved by 0.5% in March, following a 1.0% rise the previous month.

Friday’s data also revealed a narrowing of the UK trade deficit to GBP1.10 billion in March from GBP2.29 billion in February. This was driven by a faster decline in imports than exports. Imports fell by 2.5% in March, particularly in machinery, transport equipment, and fuels. Meanwhile, exports decreased by 1.3%, with lower exports to non-EU countries partly offset by increased exports to the EU.

Inflation Set to Slow Down

In the short term, the Bank revised its inflation expectations, with the “most likely” path predicting a fourth-quarter rate of 4.6%, a slight reduction from the 4.9% forecast in August. However, it raised its outlook for the fourth quarter of the following year to 3.1%, up from the previous 2.5%.

The return to below the 2% inflation target is expected in the fourth quarter of 2025, although the inflation projection for that period was adjusted to 1.9% from the previous 1.6%.

BoE forecasts for UK main economic indicators
Credit: Bank of England

The Bank of England said: “In the Monetary Policy Committee’s latest ‘most likely’ projection, taking into account the market-implied path for the bank rate, CPI inflation is projected to return to the 2% target by the end of 2025. Subsequently, it is expected to fall below the target, as increasing economic slack reduces domestic inflationary pressures.”

More recently, September’s data indicated that UK inflation remained unexpectedly resilient. The Office for National Statistics reported a 6.7% annual increase in consumer prices in September, matching the rate from August. This figure was higher than market forecasts, which had anticipated a cooling to 6.5% in September.

However, the September figure fell slightly below the BoE’s expectations. As a result, the BoE revised its expectations for gross domestic product (GDP) growth.

It lowered the fourth-quarter GDP forecast to 0.6%, down from the previous outlook of 0.9%. The projection for a year later now suggests GDP will remain flat, compared to the previous forecast of a 0.1% rise. For the fourth quarter of 2025, forecasts see growth to be 0.4%, slightly reduced from the earlier 0.5% estimate.

Inflation Reached BoE’s Target In May

The UK consumer price inflation rate returned to the Bank of England’s target after nearly three years of loftier readings, numbers on Wednesday showed.

According  to the Office for National Statistics, the rate of yearly consumer price growth faded to 2.0% in May 2024 , from 2.3% in April 2024. The reading was in-line with the FXStreet cited consensus.

The rate of inflation stood as high as 11.1% in October 2022, but has faded, albeit in a bumpy fashion, since then. The rate of inflation last sat at the target range back in July 2021.

On a monthly basis, consumer prices grew 0.3% in May, as they did in April from March. They had been expected to rise 0.4% last month, however, so the latest reading fell short of the FXStreet  cited consensus.

The yearly core inflation rate, which strips out energy, food, alcohol and tobacco, faded to 3.5% last month from 3.9% in April, as expected.

The numbers from the ONS showed annual services inflation, a gauge on which the BoE has been keeping a close eye, cooled to 5.7% from 5.9%.

The data will give the BoE some food for thought, ahead of Threadneedle Street’s interest rate decision at midday on Thursday. No change to bank rate, currently at a 16-year high of 5.25%, is expected. However, the cooler inflation readings could open the door for a summer rate cut.

The central bank’s next decision following Thursday’s is on August 1. Unlike June’s rate call, August’s decision will be accompanied by the latest monetary policy report with economic projections.

Producer Prices Decrease

Separate data  showed UK producer prices declined at a slower pace on-year in May 2024 than they did in April this year.

Producer input prices declined 0.1% annually in May 2024, the decline easing from a 1.4% fall in the prior month.

On a monthly basis, producer input prices were flat in May 2024, but topped expectations of a 0.2% fall. Prices had risen 0.8% in April 2024 from the previous month.

Eyes On Wages

Susannah Streeter, head of money and markets Hargreaves Lansdown, said: “UK inflation has made a bigger than expected jump down in its difficult descent, but it may still become stuck in the mud of viscous wage growth in the coming months. While this dramatic drop means inflation has hit the target promised by Rishi Sunak, it arguably not what the government has done but monetary policy driven by the Bank of England which is showing up in these figures.”

According to Streeter, the impact of pent-up demand from the pandemic has dwindled and supply shocks caused by the war in Ukraine have also eased off.

She said: “The energy price cap was cut in October, which as expected has fed directly into the figures, and the price of used cars has also fallen back. There’s also been an tailing off in the annual rate of food and non-alcoholic drink inflation. Prices rises for vegetables have eased considerably, falling from 14.4% to 10.8%. There is finally cheer for crisp lovers, with the snacks falling in price falling by 3.4% month on month. It’s enough to burst open a bag in celebration.”

But the party may have a short life. At 4.6%, inflation is more than double the Bank’s target. So, the prospect of cuts is still a very dim and distant hope. The Bank must get to grips with stopping domestically-fuelled inflation in its tracks and with wage growth stubborn, the higher for longer mantra is being repeated.

She added: “Although core inflation is heading in the right direction, falling 6.1% to 5.7%, risks remain. The Bank’s Chief Economist Huw Pill, speaking at the Festival of economics in Bristol said it would require “persistent restrictiveness” in policy so painful borrowing costs are set to linger. However, at this stage another interest rate rise looks unlikely given the Bank will want to wait for the lag effect of previous hikes to take effect.”

Introducing the Bank of England (BoE)

The Bank of England (BoE) is the central bank of the United Kingdom, with a history dating back to 1694. It is the second-oldest central bank globally, following Sweden’s Sveriges Riksbank.

Initially founded as a private bank to serve the government’s financial needs, the BoE received a royal charter from King William and Queen Mary in 1694. At that time, its primary mission was to raise £1.2 million in loans to finance the war against France.

Surprisingly, over 1,200 individuals from diverse backgrounds, including carpenters, grocers, merchants, doctors, knights, and even royalty, bought the bank’s shares, making them its inaugural shareholders. Notably, King William and Queen Mary themselves held shares in the bank.

As a central bank, the BoE’s primary objective is to maintain price stability by targeting an inflation rate of 2%. To achieve this, the BoE adjusts its key interest rate, as a tool to manage inflation.

The bank rate is determined by the nine-member Monetary Policy Committee (MPC). It includes the governor, three deputy governors overseeing monetary policy, financial stability, and markets, and banking.

Additionally, there is a chief economist and four external members, appointed directly by the Chancellor of the Exchequer, the second most significant cabinet member after the Prime Minister. MPC members serve fixed terms and can be replaced or reappointed. The committee convenes eight times a year, approximately once every six weeks, to decide on monetary policy actions.

Besides monetary policy, the BoE oversees banknote production, payment services, and regulates financial institutions. It also manages the UK’s gold reserves, holding about 400,000 gold bars in an impressive vault.

A Historical Glimpse at UK Interest Rates

A review of the Bank of England’s interest rate history  reveals a significant shift in approach beginning in February 2008. The global financial crisis prompted this shift, as it originated in the United States with the housing market bubble in 2007. But it subsequently impacted the UK economy.

Throughout 2008, the BoE implemented five rate cuts, reducing the rate from 5.25% in February to 2% in December. This 2% rate marked the lowest level since the banking crises of the 1880s and 1890s, as reported by the International Monetary Fund (IMF). It was also the lowest level since the Great Depression and World War II in the BoE’s interest rate history.

UK interest rates over the years
UK interest rates increased notably after the pandemic end

In 2020, the BoE made two rapid interest rate cuts on March 11 and 19. These moves drove the UK interest rates to an unprecedented low of 0.1%. This sharp reduction mirrored the emergency measures adopted by other central banks and governments worldwide to bolster their economies during the COVID-19 pandemic.

The Post-Pandemic Interest Rate Adjustment

The near-zero interest rate remained in effect until December 2021 , as the UK and other nations gradually reopened their economies. As the recovery gathered steam and inflation surged in tandem, the BoE increased the bank rate from 0.1% to 0.25% on December 16, 2021.

This marked the UK as the world’s first leading economy to raise its interest rates following the pandemic.

With the economy rebounding and commodity and energy prices soaring due to Russia’s invasion of Ukraine in February 2022, the BoE implemented eight rate hikes throughout 2022. By year-end, the bank rate had reached 3.5%.

In 2023, the UK central bank continued its tightening policy. It raised rates by 50 basis points (bps) to 4% in February. A 0.25% increase to 4.25% followed in March. And an additional 25 bps hike occurred in May, pushing the rate to 4.5%.

Post-Pandemic Pound Performance

The prospect of a more aggressive approach to interest rates by the Bank of England appears to be the primary reason for a rally that the pound began in April of this year. The markets are particularly attracted to the substantial coupon flows from British Gilts.

Sterling performance
UK pound didn’t collapse as feared after the pandemic and Brexit

UK ten-year yields are among the highest in G10 countries, even competitive with Italian BTPs. The interest rate differential (30 basis points on Italian BTPs) is thus driving the British currency to its 2023 highs. The Bank of England is watching wage growth closely.

Market expectations suggest the possibility of three to four interest rate hikes, potentially reaching 5.75% by year-end. With wages already up 5.8% year-on-year in the first quarter of 2023, they might stabilize at 5.4% by year-end. The labor market shows no signs of slowing down, with unemployment still low at 3.8%.

Assessing the Peak of UK Inflation in 2022

Inflation is playing a pivotal role in shaping the UK’s key interest rate in the short to medium term.

In 2022, UK inflation accelerated, with the consumer price index (CPI) reaching a peak of 11.1% in October. Although it temporarily receded towards the end of the year, a surprise uptick to 10.4% in February occurred. Rising food and non-alcoholic drink costs have driven the increase. Subsequently, inflation eased to 10.1% in March.

Inflation, economic growth, and labor market conditions will shape the Bank of England’s interest rate decisions in the coming years.

UK Interest Rate Projections for the Next 5 Years

Given the substantial increase in the Bank Rate at the onset of this tightening cycle, the current monetary policy stance is notably restrictive. The outlook for GDP anticipates a period of relatively stagnant growth during the first half of the forecast period. Furthermore, growth will remain well below historical averages in the medium term. This is partly due to diminishing fiscal stimulus and subdued potential supply growth.

The BoE said: “Compared to our assessment in August, the GDP forecast has been revised downward to account for recent data indicating weaker-than-expected economic activity.”

The Committee has also decided, in this forecast, to somewhat reduce the magnitude of the previous demand-boosting judgement. However, not entirely eliminating it, the BoE said.

In recent quarters, excess demand in the UK economy has decreased. Now, analysts expect a gradual increase in economic slack from the beginning of the next year. Unemployment will rise throughout the forecast period, possibly exceeding the Committee’s revised medium-term equilibrium estimate by year-end.

The bank said: “Additionally, uncertainties have arisen concerning the ONS’s official labor market activity data, primarily based on the Labour Force Survey. Therefore, the Committee continues to weigh insights from a variety of indicators.”

Following latest UK main economic indicators, the BoE sees an interest rate of 5.3% for the end of 2023. It expects a rate of 5.1% for 2024, one of 4.5% for 2025 and a rate of 4.2% for 2026.

The Impact of Interest Rates on Cryptocurrency

Cryptocurrencies, including Bitcoin, have exhibited remarkable resilience even in the face of rising interest rates. Notably, Bitcoin saw impressive growth, surging by 2,000% during the years 2015 and 2016. This was a period with increasing interest rates.

However, it’s essential to consider that elevated interest rates can have various effects on the cryptocurrency market. Persistent high inflation, rising gas prices, and increased energy costs due to higher interest rates may dampen risk appetite. They also pose challenges for cryptocurrencies, according to some experts.

Central Banks and Their Influence on Cryptocurrencies

Central banks play a pivotal role in shaping economic conditions by directly impacting money circulation and financial market stability.

Their ability to adjust interest rates directly affects borrowing rates for financial and banking institutions. In response to widespread inflation, major central banks like the Fed, ECB, and BoE have opted for interest rate hikes.

The increasingly intertwined relationship between cryptocurrencies and these macroeconomic and monetary shifts is worth noting. The decisions to increase interest rates, particularly by the Fed, have immediate consequences for the cryptocurrency markets.

In simpler terms, the more assertive stance taken by the Fed has cast uncertainty over cryptocurrencies. It influenced market sentiment as tighter monetary policies came into play.

Most central banks have raised interest rates, with a few exceptions. Simultaneously, Bitcoin’s value declined over the past year, highlighting the interaction between central bank actions and cryptocurrency markets.

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