After a long period of high inflation, the Bank of England is finally keeping its 2% inflation target firmly in its sights.
Inflation is expected to reach its target within two years and fall further thereafter, the central bank said on Thursday, as policymakers move to cut interest rates.
A majority of the bank's nine-member rate-setting committee voted this week to keep interest rates unchanged at 5.25%, the highest level since early 2018, keeping it there for nine months. However, two members voted in favor of the rate cut, compared to just one member at the previous meeting in March. Central Bank Governor Andrew Bailey also reiterated that a rate cut is most likely.
“Before cutting rates, we need to see further evidence that inflation remains low,” Bailey said in a statement. “I'm optimistic that things are moving in the right direction.”
The central bank expects inflation to be around 2.5% for most of the next 18 months. But the central bank predicts inflation will fall to 1.9% in early 2026 and 1.6% three years later. Inflation is well back from its recent peak of over 11% at the end of 2022, but the central bank is wary of prematurely declaring victory.
Like many other central banks, the Bank of England is trying to decide between cutting interest rates as inflation slows towards its target and not easing monetary policy too much due to the risk of a resurgence of inflationary pressures. I'm trying to find a delicate balance.
The US has issued a potential warning. The Fed is expected to hold off on cutting interest rates as data shows price pressures remain strong in the United States. Consumer prices rose 3.5% in March from a year earlier, higher than economists expected. But across Europe, there is growing confidence that high inflation will end and that interest rate cuts can support struggling economies. On Wednesday, Sweden's central bank cut interest rates, and European Central Bank policymakers said they expected to do the same next month.
The UK is in a difficult position in between. When the April inflation rate is released in two weeks, it is expected to show that price increases have slowed to the central bank's 2% target, due to lower household utility bills. This will be down from 3.2% in March. But the Bank of England is treading cautiously.
Some aspects of inflation remain relatively challenging. Average annual wage growth and service inflation were both 6%. For some policymakers, this level remains too high to be confident that inflation will slow to 2% sustainably.
“We're not out of inflation yet,” said Tera Arras, director of research and economics at McKinsey & Co.'s UK and Ireland office and a former civil servant economist. He said he expects inflation to fall further this year, but expects it to be “very volatile.”
“We're going to end up in a situation like the United States, where there's no longer a line in the sand,” Alas said of the decline in inflation. “It's going to go up and down, up and down, but I think it's probably at a lower level than in the United States.”
Investors have recently said they expect the Bank of England to cut interest rates in August and one more before the end of the year.
All of this is against the backdrop of lackluster economic growth. The central bank expects the UK economy to grow by just 0.5% this year and 1% next year. Much of the increase is due to population growth. At the same time, consumer spending is expected to support economic growth, with average wages rising faster than inflation and employment levels remaining relatively strong, the central bank said. But other factors will also weigh on the economy, including curbs on government spending and high interest rates that inhibit investment and lending.
The National Institute of Economic and Social Research said Thursday that the central bank will wait until August to start cutting interest rates, then cut rates again this year, twice next year, and then gradually decline until they settle at 3.25. percent.
Paula Bejarano Calvo, an associate economist at the institute, said central bankers' caution is “reasonable,” given that there remains a risk that inflation will rise further due to upward pressure on prices, including from the services sector. ”