Bank of England governor Andrew Bailey said UK interest rates are probably “near the top of the cycle” because a further “marked” drop in inflation is likely this year, a sign that the central bank may bring to an end its quickest tightening cycle in three decades.
(Bloomberg) — Bank of England governor Andrew Bailey said UK interest rates are probably “near the top of the cycle” because a further “marked” drop in inflation is likely this year, a sign that the central bank may bring to an end its quickest tightening cycle in three decades.
Testifying to Parliament, Bailey and two colleagues from the nine-member Monetary Policy Committee sent the clearest signal yet that the BOE is worried that further tightening could cause an unnecessarily harsh recession.
The governor said much of the surge in the key rate to 5.25% from 0.1% at the end of 2021 is yet to be felt. The impact of soaring mortgage costs and the sharpest cost-of-living squeeze in generations is weighing heavily on households, darkening an already gloomy outlook.
“We’ve definitely got a substantial amount of transmission to come,” Bailey told lawmakers Wednesday in London. “It appears that there is a longer transmission, that the lags are longer. We have to factor that in our policy decision.”
The pound fell to a three-month low after the remarks, and investors reined in bets for further rate hikes. The UK currency declined 0.7% against the dollar to below $1.25 for the first time since June, with markets interpreting the comments as evidence of a dovish policy shift.
Inflation was in double digits at the start of the year but has now dropped to 6.8%. Bailey said, “indicators are signaling the fall in inflation will continue” and that in terms of rates, “we are much nearer the top of the cycle.”
His hint about that the BOE may have little more to do to return inflation to the 2% target built on comments made last month by other MPC members. Deputy Governor Ben Broadbent and Chief Economist Huw Pill argued that rates are likely to remain higher for longer. Pill added that a steady level of high rates was preferable to a spike up followed by a steep fall.
Taken together, the comments suggest a majority of the BOE’s nine-strong committee is preparing for a pause in policy. Investors have fully priced in two more quarter-point rate hikes by February, but in recent days market pricing has introduced doubts about one due at the next meeting on Sept. 21.
Major central banks have been shifting their policy stance amid signs that the aggressive moves since 2021 are taming inflation and curtailing activity. The annual US Federal Reserve conference last month in Jackson Hole, Wyoming, cystalized some of that thinking, with Chairman Jerome Powell suggesting rates will remain high for some time but that officials will move “carefully.”
The BOE’s tone about the UK has changed sharply in the past few months. In February, the central bank delivered its biggest ever upward revision to growth forecasts, erasing the prospect of a recession this year.
Last month, the Office for National Statistics said the UK performed more strongly than expected during the pandemic in 2021, raising Britain above Germany in terms of growth in the Group of Seven.
“We’ve been telling a story about the fact that we think the economy has been more resilient than we expected to be and of course, the revision helps with that story,” Bailey said.
More recent data tracking the sentiment of purchasing managers and for retail sales showed unexpected weakness, with surveys indicating businesses and consumers are feeling an increasing strain from higher rates.
The apparent shift in sentiment at the BOE has come despite faster than expected wage growth last month. Rather than stress the overshoot, Deputy Governor Jon Cunliffe, who appeared before MPs alongside Bailey, said the economic “evidence is mixed, which is what you expect when you come into periods where you might be close to turning points.”
Also testifying, Swati Dhingra, an external member of the MPC who has voted to hold rates for months, dismissed the pay data as a “lagging indicator.” She said policy was restrictive enough already and any further rate rises risk hurting growth.
“A recession poses a risk to our inflation mandate so that is something we would not like to happen at all,” Dhingra said. Cunliffe agreed and clarified that a recession would potentially lead to an inflation undershoot, which would not comply with the 2% mandate.
Asked about the risk of a recession, Bailey warned: “We can’t always say we will avoid it.” Headline inflation may tick higher when figures for August are released on Sept. 20 but a small increase wouldn’t change his overall outlook for a marked decline, he added.
“Inflation is coming down, and our sort of short term forecast is performing better. I think it is, I should say possible that we will get a tick up in the next release because fuel prices went down in August last year and went up a bit in August this year.”
Cunliffe said credit conditions were tightening and company indebtedness is climbing “but nowhere near to the levels that we’ve seen in past peaks.” “I don’t think we’re seeing anything like a credit crunch at the moment.”
Elisabeth Stheeman, a member of the BOE’s financial policy committee that oversees financial stability, warned that the committee is worried about the impact of high rates on commercial real estate.
–With assistance from Eamon Akil Farhat, Andrew Atkinson and Katherine Griffiths.
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