Sep 19 2024: The Bank of England (BoE) is expected to keep interest rates unchanged on Thursday as it monitors inflation risks, shifting attention to its bond sales strategy, which could influence Finance Minister Rachel Reeves’ first budget.
In August, British inflation remained steady but accelerated in the services sector, a key focus for the BoE. This has led forecasters to believe that interest rates in the UK will fall more gradually than in the U.S. and the eurozone.
On Wednesday, the U.S. Federal Reserve made a substantial half-percentage-point rate cut, signaling confidence in controlling inflation, according to Chair Jerome Powell. In contrast, the BoE’s Monetary Policy Committee (MPC) is expected to adopt a more cautious stance.
According to a Reuters poll, all 65 economists surveyed predict that the BoE will hold its interest rate at 5.0%, following a cut from 5.25% in August. Financial markets indicate a roughly 1-in-4 chance of a rate cut after the latest inflation data.
The outlook for inflation has been mixed. While wage growth slowed as expected and the economy stagnated in July, the BoE’s Decision Maker Panel, a key business survey, revealed that wage growth expectations have plateaued. Additionally, services inflation edged up in August, driven in part by volatile airfares.
Tim Graf, head of macro strategy at State Street Global Markets, said the recent inflation data supports the belief that the BoE will hold rates steady.
Quantitative Tightening in the Spotlight
Bond investors are closely watching the BoE’s annual decision on the pace of its quantitative tightening (QT) program, which involves selling off government bonds accumulated during past efforts to stimulate the economy.
In September 2023, the MPC decided to reduce the BoE’s stock of gilts by £100 billion, up from £80 billion in the previous year. However, some lawmakers have criticized the QT program due to the financial losses incurred by the BoE, which bought these bonds at higher prices than their current sale value—costs borne by taxpayers.
The BoE may announce an acceleration of the QT program, with around £87 billion of gilts maturing over the next year, leaving £13 billion for active sales. Both Citi and JPMorgan predict the BoE could expand its QT program to £120 billion to maintain active bond sales at a steady pace.
JPMorgan’s head of UK, euro, and global inflation strategy, Francis Diamond, stated that market reaction to such a move would likely be limited. BoE Governor Andrew Bailey has indicated that QT is necessary to restore the central bank’s ability to stimulate the economy with future bond purchases.
Finance Minister Rachel Reeves is also likely to be paying close attention to the QT decision, given its potential impact on the state budget. Although Reeves has stated that QT is an operational matter for the BoE, some economists believe she may adjust fiscal rules to exclude the impact of QT, which could provide several billion pounds of additional fiscal space for her upcoming budget on October 30.
The New Economics Foundation has estimated that continuing bond sales at the current pace could cost taxpayers nearly £24 billion annually until 2028/29, but halting active sales could save £13.5 billion each year.
“The Bank of England should reconsider the value for money of these decisions, and the Chancellor should address how fiscal rules are affecting spending choices,” said NEF economist Dominic Caddick.
(Exchange rate: $1 = £0.7648)
