BoE cuts interest rates to 4.75% as inflation eases

The Bank of England’s Monetary Policy Committee (MPC) made the decision to lower the Bank Rate by 0.25 percentage points to 4.75% on November 7, marking a gradual shift toward a less restrictive monetary policy.

This decision, reached by a majority vote of 8-1, reflects both progress in reducing inflation and the need to address ongoing economic challenges.

The reduction follows a period of cooling inflation pressures, especially in goods prices, while services prices and wage growth continue to present challenges. #

As inflation nears the government’s 2% target, the MPC sees an opportunity to cautiously adjust the Bank Rate, though its members expressed differing perspectives on the pace of this transition.

A Vote for Gradual Policy Change

In the committee’s vote, eight members opted to lower the rate to 4.75%, while Catherine Mann voted to maintain the Bank Rate at 5%. Her vote against the cut highlights concerns over inflationary persistence and structural shifts in wage and price-setting behaviours that could drive up costs in the medium term.

The MPC’s rate cut underscores a nuanced approach to balancing inflation control with economic stability. Although inflation has fallen significantly, from 2.3% to 1.7% as of September, the MPC’s projections indicate that it could rise to around 2.5% by the end of the year.

This anticipated increase is due to factors such as the diminishing effect of falling energy prices on the inflation calculation. According to the MPC, these dynamics reinforce the need for a cautious stance, as a premature easing of rates could risk reigniting inflation.

Inflation Trends and Economic Growth

The Bank’s decision comes amid indications of an easing inflationary environment. While the Consumer Prices Index (CPI) inflation rate reached 1.7% in September, a notable drop from earlier peaks, the committee warns that challenges remain.

Goods inflation has slowed considerably, but inflation in services — including the volatile elements of food and energy — has not declined as sharply, holding steady at 4.9% in recent months.

Private-sector earnings growth has also been high, with annual wage increases averaging 4.8% over the past quarter, a trend the MPC attributes to a tight labour market.

Although the labour market is loosening, it remains tighter than historical standards would suggest, contributing to inflationary pressures through continued wage demands. The potential inflationary effects of wage growth and other labour costs could limit the speed of monetary policy easing.

GDP growth for 2024 has been steady but subdued, growing by 0.5% in Q2. However, it has fallen short of initial forecasts, with underlying growth projected at around 0.25% per quarter for the remainder of the year. The MPC’s November forecast anticipates limited economic slack, indicating that aggregate demand and supply are still closely aligned. This balance implies a delicate environment where restrictive monetary policy remains necessary to avoid stoking inflation.

Autumn Budget 2024: Fiscal Policy’s Role

Fiscal policy announced in the Autumn Budget 2024 plays a pivotal role in the Bank’s outlook. The budget is expected to boost GDP by approximately 0.75% at its peak next year, relative to August projections. Although this growth is positive, it introduces further complexity into the inflation equation.

The budget measures are expected to add around 0.5 percentage points to CPI inflation at their peak, largely due to increased spending and a smaller margin of economic slack.

Changes to National Insurance contributions (NICs) and the National Living Wage (NLW) further complicate the outlook. These adjustments are expected to elevate employment costs, impacting prices and wages in the coming months. The extent to which these costs filter through to pricing, wages, or profit margins remains uncertain and will shape the Bank’s policy decisions in the months ahead.

Chancellor of the Exchequer, Rachel Reeves, said: 

“Today’s interest rate cut will be welcome news for millions of families, but I am under no illusion about the scale of the challenge facing households after the previous Government’s mini-budget.

“This Government’s first Budget has set out how we are taking the long-term decisions to fix the foundations to deliver change by investing in the NHS and rebuilding Britain, while ensuring working people don’t face higher taxes in their payslips.”

Persistent Inflation and MPC’s Three-Scenario Framework

The MPC outlined three scenarios for inflation persistence, indicating various factors that could shape the path of price pressures. In the first scenario, inflationary pressures could ease quickly if wage and price-setting dynamics continue to normalize as global shocks dissipate.

The second scenario suggests a more prolonged journey, where economic slack might be necessary to fully return inflation to target. Finally, a third scenario considers that structural changes in wage and price-setting behaviours could lead to sustained inflation, even in the face of slower economic growth.

Given the varying probabilities of these scenarios, the MPC has opted for a measured approach, leaving open the possibility of further reductions if inflation continues to trend downward. This cautious stance reflects the committee’s focus on mitigating inflation persistence without destabilizing growth.

Labour Market Dynamics and Policy Implications

The tight labour market remains a key factor in the Bank’s inflation forecasts. Despite signs of easing, it has not loosened enough to significantly reduce wage pressures. With private-sector earnings growing at an annual rate of 4.8%, employers are facing rising labor costs, a situation exacerbated by the budget’s changes to the NLW and NICs. These increases may limit businesses’ capacity to absorb costs without passing them on to consumers, thereby fuelling inflation.

MPC members noted that the inflationary impact of higher wages and employment costs depends on firms’ pricing power and profit margins. If businesses face limited opportunities to raise prices, wage growth might moderate as demand for labour declines. However, should firms pass these costs onto consumers, the MPC warns that inflation could persist longer than anticipated, complicating the Bank’s efforts to reach the 2% target.

The Path for Monetary Policy

The MPC’s November projections, based on a gradual easing of inflation pressures, anticipate CPI inflation returning to around 2% in the medium term, as economic slack emerges and acts against price and wage pressures. However, the committee noted that if downside news on wages and services inflation materialises, it may lean toward a faster reduction in rates.

The decision to lower the Bank Rate to 4.75% marks a step toward policy normalization, yet the committee emphasises that monetary restraint will remain in place as long as risks to inflation linger. With a measured approach, the Bank of England will continue to closely monitor economic data, making adjustments to the Bank Rate in line with evolving inflation risks.

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