Pound Tumbles After Bank of England Cuts Rates While Warning Of Mounting Stagflation; Two Officials Vote For Bigger Cut
While the Fed engages in navel-gazing how much Trump’s tariffs will raise inflation by, and according to Goldman the answer is by a whopping 0.5% to 2.6% (from 2.1% in the absence of tariffs)…
… the rest of the world continues to quietly stimulate its economies by injecting more reflationary liquidity into the system, and this morning the Bank of England was the latest to do so when it not only cut rates for the third consecutive time by 0.25% to a 19-month low of 4.5%, as expected…
… but in a surprise to the market, two of the nine MPC members voted for a bigger, 50bps rate cut, which in turn prompted markets to boost bets on more easing ignoring the BOE’s own phrasing.
The Monetary Policy Committee voted by a majority of 7-2 to reduce #BankRate to 4.5%.
Find out more in our #MonetaryPolicyReport https://t.co/alETrQ281L pic.twitter.com/Vuo5G6m1H8
— Bank of England (@bankofengland) February 6, 2025
There was another twist: in a blow to UK chancellor Rachel Reeves, the BoE slashed its growth forecast saying it now expected the economy to grow by only 0.75% this year, half its November forecast of 1.5% which, would at least justify the rate cut…
… but the BOE also upgraded its inflation forecast, which now peaks at 3.7% because of higher energy prices, and up from the prior projection of 2.8%. In other words, the UK is now in a stagflationary trap, yet in a world where no more pain can be tolerated the central bank’s obvious reaction was to cut rates more.
The bank’s outlook is a bleak backdrop for Reeves, who has presided over a collapse in growth since Labour won the general election last July. The BOE believes the economy contracted 0.1% in the three months to December, the quarter that included Reeves’ tax-raising budget on Oct. 30, and will grow just 0.1% in the first quarter of 2025.
The growth forecast for this year has been halved to 0.75% but picks up to 1.5% in 2026 and 2027, from the prior projection of 1.25% in both years. The bank said its forecast is “not conditional on any change in global tariffs” but that a trade war could depress UK growth by “delaying investment spending and hiring decisions.”
Amid this cacaphony of swirling outlooks, it is no surprise that the MPC signaled a “gradual and careful approach” to future rate cuts, warning of uncertainty due to, what else, Trump tariffs and suggesting in their forecasts that only two more reductions were needed to bring inflation back to the 2% target.
The addition of the word “careful” to the bank’s core guidance for future easing reflected questions about the global economy, according to Bailey. “We live in an uncertain world, and the road ahead will have bumps,” he said.
“Some domestic inflationary pressures remain and may have eased a little more slowly than we expected last year,” Bailey told reporters after the decision. “And that reaffirms the importance of taking a gradual approach to the withdrawal of monetary policy restrictiveness.”
Despite Bailey’s cautious languages, traders focused on the calls from two policymakers for a sharper reduction, adding to bets on future interest-rate cuts. Money markets are now favoring three more 25-basis-point reductions this year.
That hurt the pound, which extended declines versus the dollar dropping as much as 1.2% to $1.2361. It was the worst-performer among major currencies on Thursday. Two-year gilt yields fell as much as seven basis to 4.07%.
In response to the rate cut, Matthew Landon, strategist at JP Morgan Private Bank said that „at the margin, we interpret this is a green light for the market to price a lower terminal rate.” He added that „today’s cut from the Bank of England was broadly expected, though the accompanying statement contained some mixed signals.”
The MPC’s decision to reduce its rate to the lowest level since June 2023 represents a reprieve for the more-than-half-a-million homeowners coming off five-year fixed mortgage deals this year. Reeves called the decision “welcome news,” but expressed disappointment with the broader outlook provided by the bank saying she was “still not satisfied with the growth rate.”
Rob Wood, chief UK economist for Pantheon Macroeconomics, said he placed “more weight” on the bank’s hawkish inflation forecasts, a relatively strong pay settlements survey and its overall guidance “than the votes of two outliers.”
Bailey seemed to support that view in remarks to reporters after the decision: “I would not overinterpret any other moves in voting patterns,” he said, adding that “it’s important that the view on the future path of interest rates is based on the economic fundamentals.”
Also behind the change was a downgrade to the bank’s estimate of UK growth capacity, which makes faster growth inflationary. It halved its estimate to 0.75% this year but expects potential growth to return to 1.5% from 2026. The bank blamed the downgrade on persistently weak productivity and suggested Labour’s increased spending on the National Health Service may make the position worse.
There were no material changes to the bank’s forecasts following Reeves’ recently announced plans to boost growth by relaxing regulations and waving through infrastructure projects.
“It is hard to see the Bank of England materially stepping up its pace of easing until it sees how the increase in National Insurance is digested by the economy in the spring,” said Luke Bartholomew, deputy chief Economist at Abrdn. “However, the Bank’s signals today suggest there is scope for several more rate cuts this year, given the weak growth outlook, and we continue to see rates below 3% over the next two years.”
Tyler Durden
Thu, 02/06/2025 – 09:15
