Pressure from all sides: examining the case for the Bank of England to lower interest rates

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Since August 2023, the official policy rate of the Bank of England has been 5.25%, the highest since early 2008. This stands in stark contrast to the ultra-low interest rates persistent across the 2010s, never increasing beyond 0.75%. With the UK demonstrably entering a period of disinflation over the past 12 months, with prices falling or growing more slowly, there have been repeated calls for the Bank of England to cut interest rates to spur on growth and investment.

Inflation currently stands at 3.2%, far lower than the giddy heights of the 11.1% inflation figure of October 2022. Despite this reduction, inflation is still higher than the Bank of England would like, who pursue a 2% target, and accept inflation figures 1 percentage point either way of this. With disinflation likely to continue, most economists are expecting the UK will imminently return to this acceptable band of inflation, and potentially move under the 2% target at some point in 2024.

Ongoing positive discussions around disinflation do disguise major outliers in the data. Whilst most goods have seen relatively stationary or only marginally increasing prices in recent months, with energy costs in particular falling, the rate of inflation in services is still 6%. Not only is this a significant figure in itself, it is also far higher than comparable rates in the US or the Eurozone, with this UK-specific problem perhaps requiring a unique approach by the Bank of England’s Monetary Policy Committee (MPC).

There is clear pressure for the Bank of England to cut rates

Amid the next MPC decision on interest rates on 9 May, there is clear pressure for the Bank of England to cut rates. With UK economic growth only estimated to be 0.5% in 2024, a far lower estimate than for any other G7 economy, cutting interest rates might be crucial in boosting growth and investment. Outside of this, many Conservative factions are also encouraging a reduction in interest rates to promote a fall in mortgage costs, which remains a stubborn obstacle in attracting voters.

However, both the Conservatives and the Labour Party are seeking for the next electoral period to feature an upswing in investment, especially towards green energy initiatives. Reducing interest rates, which effectively reduces the total cost of undertaking investment, thus would be a boon electorally for the next government, regardless of its tribe. The investment problem in the UK is far-reaching but also endemic, with the rate of private sector investment in the UK trending below any other G7 economy since 2005.

Were the Bank of England to seek to restore confidence that the UK economy is growing and living standards should improve a cut in interest rates might be the best option. It is widely expected interest rates will fall at least once this year, but recent predictions have suggested interest rates might be cut twice, in the summer and then towards the end of the year, causing a larger overall reduction in interest rates across 2024.

The 6% inflation figure for services remains an obstacle for many MPC members

The Bank of England is far from united on whether to lower interest rates. The 6% inflation figure for services remains an obstacle for many MPC members, and without clear signs this rate is reducing in line with US or Eurozone levels, interest rates might remain high. Equally, global conditions are not optimistic. Speaking recently to economists and investors in Washington, DC, Megan Greene – a member of the MPC – spoke on the risk of another supply-side crisis being triggered by the Israel-Gaza conflict. This would perhaps be reminiscent of the situation provoked by Russia’s invasion of Ukraine in 2022, albeit perhaps not to the same extent.

Globally, the Federal Reserve has approached the problem differently, firm that it will keep interest rates at current levels across 2024. Amongst other reasons, the US has a 2.7% forecasted GDP rate in 2024, and higher interest rates might be needed to rein in growth to suitable levels. Meanwhile, whereas inflation in the UK was prolonged by a tight labour market and high wage growth, US inflation has been dominated by consumer demand. For this reason, it might be natural for the Federal Reserve and Bank of England to take different strategies on interest rates, despite their long history of similar decisions.

The recent discourse on UK monetary policy has been compounded by a 75-page report published by Ben Bernanke, former head of the Federal Reserve in the late 2000s, on the inner workings of the Bank of England. Most notably, Mr Bernanke has deplored the lack of change in Bank of England strategy since it became independent in 1997. Suggested improvements include the Bank of England publishing its own expectations on how inflation will change in the coming months, as is done by other central banks including the Federal Reserve. Not only might this improve the integrity and transparency of the Bank of England, but it also might improve investor confidence to solve the UK’s under-investment problem.

It is incredibly likely interest rates will be cut at least once in 2024, but doubts still remain as to how many times, and how significant these cuts are. Following the US approach seems imprudent, given the significant disparities in GDP estimates for 2024, yet the Bank of England will have to weigh up the benefits of propelling growth given the wider economic context, most crucially the implications of the Israel-Gaza conflict.

Image: Colin Smith via Wikimedia Commons

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