The Bank of England (BoE) could start cutting interest rates before the US and the Eurozone despite previous expectations. On Thursday, the BoE held its key rate unchanged at a 16-year high, just hours after the Swiss National Bank became the first rich country to lower interest rates. The decision marks two years since central banks around the world started their aggressive efforts to combat high inflation.
Last week, the Bank of England left interest rates on hold for the fifth meeting in a row. Governor of the BoE, Andrew Bailey, said inflation was “moving in the right direction” indicating that rate cuts should be expected.
Markets forecast the first rate cut to come in June, while some investors are even saying that a rate cut could come as early as in May.
Expectations for interest rate cuts
The market is speculating that the Bank of England will be the first among the major central banks to reduce interest rates. Now, the BoE has a 20% chance of cutting rates, while the Fed and the ECB have less than 10% chances. This is a complete change that will have serious implications for the pound which has significantly weakened this month.
It comes after Andrew Bailey said that cuts in interest rates were “on the way” as interest rates had reached 16-year highs at 5.25%.
Citi strategist, Jamie Searle, believes this may mean that May could be the month for a cut.
Britain was supposed to be the last one to lower rates compared to the Federal Reserve (Fed) and the European Central Bank (ECB) due to persistent inflationary pressures.
The Bank of England may cut the costs for borrowing to a minimum of 3% next year as it follows a path of lower inflation, based on the latest forecasts.
Easing inflation to accelerate rate cuts
According to analysts at consultancy Capital Economics, the Bank of England may have to lower interest rates at a pace faster than what is expected by the markets because of the fall in inflation. They noted that “The UK is on the cusp of switching from having a bigger high inflation problem than other major economies to having a bigger low inflation problem.”
UK inflation, which reached over 11% in October 2022, has declined sharply because of the drop in food and energy prices. Last week’s statistics revealed that it went down to 3.4% in February.
Economists believe that this should happen in April with Ofgem’s energy price cap.
While there is some debate about what is going to happen for the rest of the year, Capital Economics projects inflation to go down as low as 0.5% in 2024. Inflation will stay below the 2% target for all of 2025 and 2026, as the UK’s economic weakness does not provide the conditions for any price rebound.
Capital Economics said that “The legacy of the weak economy over the past year and the loosening in the labour market will probably prompt businesses in the services sector to raise their wages and selling prices more slowly.” They believe that investors will be caught by surprise when the Bank of England lowers interest rates decisively.
KPMG’s economists also expect that interest rates will drop to 3% in 2025. They anticipate that the easing of inflationary pressures would allow the Bank of England to cut interest rates from the second quarter of the year. They speculate that interest rates will drop by 100 basis points in 2024 and the cycle will end at 3% by the second half of 2025.