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There were two big question for economists and financial markets after the Bank of England’s meeting on Thursday.
After halting the seemingly relentless rise in interest rates since December 2021, for how long will borrowing costs remain high? And when will they start to come down?
In a deliberately vague statement the BoE said it now saw interest rates as “restrictive”, and the slim majority on its Monetary Policy Committee in favour of holding them wrote in the minutes that borrowing costs should stay at 5.25 per cent “until material progress had been made in returning inflation to the 2 per cent target sustainably”.
Publicly and privately BoE officials stressed that they did not want to give clear guidance on the next move for rates, apart from stressing that decisions in the coming months would be choices between holding them or raising them further. They did not mention any possibility of cuts.
The MPC thinks it can now leave rates on hold until the inflation threat has passed, in a strategy BoE chief economist Huw Pill last month termed “Table Mountain”.
He suggested that rates, having risen quickly, would resemble the long flat massif that towers over Cape Town in South Africa, before gradually coming down some time in the future. That would allow inflation to be vanquished without too much pain.
If the message from the MPC was supposed to bring that shape to financial futures markets, it appeared on Thursday to be a success.
In the wake of the BoE decision, expectations of rate rises were almost flat at 5.25 per cent or a little above. By contrast, in July financial markets were expecting rates to rise further to 6.5 per cent by mid-2024.
Officials would like the “Table Mountain” shape of interest rates to become ingrained in the public imagination because it would keep borrowing costs high, raise the return on savings and maintain the brakes on the economy, keeping downward pressure on inflation.
The central bank wants the public to be clear that interest rates will not come down soon and they must adjust to a world of higher borrowing costs and lower spending.
However, the problem for the BoE — one that is also faced by the US Federal Reserve and the European Central Bank — is that it will find it hard to commit to keeping rates high for a prolonged period. If an economic downturn were to gather pace, it would come under pressure to cut rates quickly.
Kallum Pickering, senior economist at Berenberg bank, said “economic weakness and a further fall in the pace of inflation [will] force the BoE to turn less hawkish and begin to lay the ground for rate cuts, probably from spring onward”. He predicted interest rates would fall to 4 per cent by the end of 2024.
Martin Beck, chief economic adviser to the EY Item Club, said the BoE might well be bluffing with its higher-for-longer language. “It’s not implausible that the MPC’s messaging doesn’t prove an exact guide to the actual direction of policy,” he said.
“Were inflation to repeat August’s downside surprise and there were signs that pay growth is on the turn to continue to build, the committee could change its stance, with cuts perhaps beginning early next year.”
For now, however, this is a minority view, with most economists and financial markets willing to take the BoE’s guidance at face value.
Financial markets also think UK rates will begin falling this time next year but will be slow to come down.
However, if inflation declines rapidly and the economy weakens substantially, the BoE’s Table Mountain strategy is likely to slip. The past two months shows how quickly interest rate expectations can change.