As the specter of stagflation (stagnant growth and high inflation) looms over the economy, the Bank of England is expected to send cautious messages to investors by the end of the year. The central bank is still expected to remain on hold on Thursday but may warn that rate cuts will only be gradual through 2025.
Markets and economists expect the nine-member Monetary Policy Committee (MPC) to keep the benchmark rate unchanged at 4.75% on Thursday. The Bank of England will announce its last interest rate decision of the year on Thursday at 20:00.
Given the brewing inflation threats both domestically and internationally, Bank of England Governor Bailey and his colleagues may adopt a cautious tone. The risk of a global trade war triggered by Trump's return to the White House and the uncertainty of the impact of the UK budget further darken the economic outlook.
After cutting rates by 25 basis points in August and November, Bailey hinted earlier this month that cuts could continue quarterly. However, after wage growth exceeded expectations and service sector inflation stagnated at high levels, traders have recently scaled back their rate cut bets. They currently expect only two cuts next year, meaning monetary policy will continue to weigh on an economy that has already lost momentum.
Bank of England rate cut bets cool.
Voting proportions.
Economists expect the Bank of England to support keeping rates unchanged with a vote of 8 to 1, meaning the likelihood of an unexpected rate cut is almost zero.
Swati Dingra will be the only dovish member supporting another rate cut, having advocated for cuts at every meeting since February this year. If anyone joins her, it is likely to be Deputy Governor Dave Ramsden or the newly appointed rate setter Alan Taylor. Both have indicated that their likelihood of voting for faster cuts would increase if the downside risks to economic growth and inflation materialize. However, unexpectedly strong wage growth on Tuesday may convince them not to oppose this time.
Bank of England Monetary Policy Committee Hawk-Dove Spectrum
Policy guidance.
Economists expect the Monetary Policy Committee to largely maintain the guidance from the November meeting and warn investors that they expect only 'gradual' rate cuts.
The Bank of England may reaffirm its approach of making decisions in successive meetings and state that policy needs to 'remain restrictive for a sufficiently long time' to eliminate the persistent inflation threat. As investors try to estimate where interest rates will eventually stabilize, the Bank of England is facing increasing pressure to restart discussions on the so-called neutral interest rate—the level of interest rates that neither restrains nor stimulates growth. However, policymakers show few signs of wanting to do so.
The Bank of England's room for further rate cuts is limited.
Investors may find more clues in comments about voting divergences. Previous minutes emphasized the broad view of the majority and indicated that some policymakers were close to supporting rate cuts. This could lay the groundwork for rate cuts in February next year.
'We believe the Bank of England has no interest in deviating from the message of gradual rate cuts,' said Bruna Skarica, chief UK economist at Morgan Stanley.
Growth and inflation outlook.
After a series of disappointing data, the Bank of England may downgrade its economic growth forecast for the fourth quarter. The central bank's November forecast was 0.3%. However, the unexpected 0.1% decline in October GDP and the pessimistic warnings about the impact of budget tax hikes in the survey suggest that the central bank may be overly optimistic. Bloomberg Economics has downgraded its forecast to just 0.2%.
UK GDP shrinks for two consecutive months.
With this week's data showing wage growth rebounding for the first time in over a year and inflation hitting an eight-month high, concerns about inflation have resurfaced. The Bank of England may comment on the unexpectedly high overall and service inflation rates from last month.
Traders will also attempt to understand which of the three inflation scenarios from the Bank of England is most likely to occur.
The UK inflation outlook has various possible outcomes, including benign scenarios and scenarios where structural changes mean that restrictive policies need to be maintained for a longer time. The Bank of England's current forecasts are based on a central scenario, which requires more signs of economic weakness for rates to continue falling.
In the minutes from the November meeting, the Bank of England wrote, 'In the first scenario, as global shocks driving inflation dissipate, wage and price dynamics continue to normalize, and remaining inflation could quickly dissipate. In the second scenario, a period of economic weakness may be needed for these dynamics to fully normalize. In the third scenario, some persistent inflation may also reflect structural changes in wage and price setting behavior. Each of these scenarios will have different implications for the speed at which monetary policy restrictions are lifted.'
Impact of tax increases on inflation.
The Bank of England may provide investors with more views on the impact of Chancellor Rachel Reeves' proposed £26 billion ($33 billion) increase in employer National Insurance contributions, which is a core element of the Labour government's first budget announced on October 30.
UK businesses face a £26 billion tax increase.
Policymakers are uncertain how businesses will react, such as potentially raising prices, cutting jobs and hours, restraining wage growth, or impacting profit margins. A survey of CFOs by the Bank of England indicates that consumers will feel the impact in some way.
RSM UK economist Thomas Pugh said, 'The interest rate outlook for next year will largely depend on how businesses respond to the increased wage costs in the budget.'
Article forwarded from: Jin Shi Data.