Emphasis on economic slowdown: Although a majority of six Monetary Policy Committee (MPC) members voted to keep the Bank of Englandâs bank rate on hold at 4.75% at their December meeting, the three who dissented by voting for a cut provided an unexpected dovish twist. Until now the MPCâs focus has been squarely on inflationary pressure, which has surprised to the upside since the last meeting. The dissenters instead put most weight on sluggish demand and a weakening labour market, arguing that high interest rates could cause an âunduly large output gapâ to open up which puts too much downward pressure on inflation. A more dovish approach feels risky to us. Any positive impulse to demand would allow firms to pass on more of the large increase in labour costs they face to customers by raising prices, keeping inflation higher for longer. In our view, the BoE will only be able to cut twice next year before above-target inflation forces it to reassess. Despite the dovish vote split, investors continue to agree with us on the number of interest rate cuts in 2025 â see Chart.
A wide range of opinion: Although the minutes maintained the line that âa gradual approach to removing policy restraint remains appropriateâ, differences of opinion are widening on the MPC. The new statement that the MPC will assess whether the data is consistent with weak demand or constrained supply reveals that the hawks are currently reluctant to ease policy much further. One of the six members that voted for a hold (likely Catherine Mann) did not agree with removing policy restraint. Instead, she preferred an âactivist strategyâ of keeping interest rates unchanged until inflation was definitely under control. Other members endorsed the gradual easing language while âeschewing any commitment to changing policy at a specific meetingâ. That suggests many of the other five that voted to keep bank rate unchanged at this meeting are far from sure that they will be ready to vote for a cut at the next on 6 February.
Adverse scenario dropped: The MPC downplayed the increase in pay growth in October,but it could just as easily have ascribed the recent data to structural changes in the economy that lead to persistent wage and price pressures even as the economy slows. In fact in the November minutes the MPC said âa slowing in the disinflation process, particularly in the absence of a pickup in activity growthâ¦â would be indicative of such a scenario, and warrant higher interest rates for longer. In our view, the recent evolution of the data is most consistent with this more hawkish view of the world. Instead, the MPC dropped all three of its scenarios from the minutes at this meeting.
Ok demand and above-target inflation limits room for cuts: It is questionable just how restrictive interest rates currently are. Domestic demand increased by 2.4% yoy in Q3 alongside a recovery in housing market activity to pre-pandemic levels and increasing bank lending to households and firms. Alongside the 0.8ppt contribution to growth from government consumption which we expect in 2025, this suggests quarterly growth rates will improve in the new year. Meanwhile, increases in the minimum wage and higher taxation on employers point to more cost-push inflation. We expect inflation to rise to an average of 3% over the second half of 2025. If we are right, then the BoE will probably have to stop after merely two further cuts, keeping interest rates on hold at 4.25% thereafter.
Chart: Bank Rate forecasts |
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In %. Market-implied paths based on OIS rates and Berenberg calculations. Consensus from Bloomberg on 19 December. Sources: Haver, Bloomberg, Berenberg. |
Andrew Wishart
Senior UK Economist
+44 20 3753 3017
