Bank of England’s Quick Pivot Puts June Rate Cut in Focus

(Bloomberg) -- The Bank of England has laid the groundwork for a shift to rate cuts after one of the sharpest turnarounds in guidance in recent memory, with data releases, investor bets and the UK’s political calendar pointing to June for the first move.

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Across just two months, Britain’s central bank has repositioned itself from a bias for higher borrowing costs to be poised for reductions. Two of the most hawkish rate-setters dropped their calls for hikes on Thursday, moving off a position that had struck many observers as out of step with recent data.

Governor Andrew Bailey needed to move quickly. The Monetary Policy Committee entered the new year with a guidance that hadn’t changed since August, when inflation was 7.9%. It soon became clear that the economy was already in a recession and that tumbling natural gas prices would lower inflation close to the BOE’s 2% target as soon as April. Calls grew for a pivot — and fast.

“We think the balance of risks is tilted to the bank moving more quickly than we think — June rather than August,” said George Buckley, an economist at Nomura. “The BOE has set the groundwork that it’s ready to cut its policy rate.”

Following Thursday’s decision to hold rates at 5.25%, financial markets raised their bets for a first cut in June — fully pricing in a reduction in August — followed by two more this year. That would take rates to 4.5% by December. The UK was “on the way” to winning its fight against inflation, Bailey told broadcasters after the rate decision.

The BOE chief continued to strike an upbeat tone in a separate interview with the Financial Times. “The fact that we have a curve that has cuts in it for the year as a whole is not unreasonable to me,” Bailey told the newspaper, adding that “all our meetings are in play.”

Preparing the ground for a rate cut was urgent because consumer price inflation has halved since July last year to 3.4% in February. The labor market has also softened. “Even those underlying drivers of inflation which have prompted the MPC’s concern are starting to look more benign,” said Martin Beck, chief economic adviser to the EY Item Club.

Political pressure on the bank is also mounting, and not just from backbench Conservative MPs demanding rate cuts to help mortgage borrowers. Chancellor of the Exchequer Jeremy Hunt dropped a hint about what he expects from the bank earlier this week, saying that “as inflation gets closer to its target, that opens the door for the Bank of England to consider bringing down interest rates.”

That lays potential landmines for officials on Threadneedle Street, eager to maintain their official independence from the Treasury. The government wants rate cuts for the boost to living standards and the economy they would deliver before a general election, which Prime Minister Rishi Sunak has said he plans to call in the “second half” of the year. Hunt twice this week suggested that the government was considering an October poll date.

If the bank is to cut rates, it needs to do so far enough ahead of the poll to avoid any appearance of political interference. It has raised rates during an election campaign only once since it was given independence in 1997.

That was in May 2001, two days after the election was called and after a rate cutting cycle had already begun. An October election this year would suggest campaigning would start in early September.

“It’s possible the bank may move the date of the November meeting to avoid a clash with an election,” said Ruth Gregory, deputy chief UK economist at Capital Economics. Officials might have to clarify that policy was “determined by the Bank’s assessment of economic conditions rather than being driven by political considerations,” she added.

The turnaround at the BOE has been striking. At the end of last year, three of the nine-member MPC were voting for rate rises.

Two meetings later, no one is voting for higher rates, and one is voting for a cut. A few of the others think rates at 5.25% are having a “material impact” on the underlying domestic inflation that remains the bank’s lingering concern, minutes of the latest meeting showed.

What Bloomberg Economics Says ...

“The Bank of England took a big step toward cutting interest rates, at its March meeting. There was a dovish shift in the vote split and an acknowledgment that its policy stance will remain restrictive even if it eases. May still looks too early for the first move, though the outcome of the March decision suggests the next meeting is likely to be ‘live’. Our view is that the first cut will come in June.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.

Furthermore, the MPC effectively redefined the meaning of “restrictive” policy without changing its guidance. The minutes said, “policy could remain restrictive even if Bank Rate were to be reduced.” That means cutting rates gradually now is almost as effective at restraining demand as raising them.

Beck said June appears to be the most likely month to start cutting rates. Part of that is due the timing of key economic releases.

The March minutes showed the BOE expects inflation “to fall to slightly below the 2% target” in the second quarter, but the April inflation print won’t be published until May 22. That’s 13 days after that month’s MPC meeting.

Also, about two-thirds of pay deals are agreed by April, and those could provide compelling evidence on whether second-round effects are getting embedded in domestic inflation. Again, that data won’t come until after the May meeting.

“It’s like the Sherlock Holmes dog that doesn’t bark,” Bailey told the FT. “If the second-round effects don’t come through, that’s good because monetary policy has done its job.”

The BOE’s new stance brings it closer into line with the US Federal Reserve and European Central Bank. While it’s the US now that has stronger-than-expected inflation, Britain has seen results over the past two months that were lower than forecast. The Swiss National Bank unexpectedly cut its key interest rate by 25 basis points on Thursday, moving months ahead of the pack.

“Central banks look to be on the verge of declaring victory in their battle over inflation,” said Hussain Mehdi, director of investment strategy at HSBC Asset Management. “Some banks – such as the Swiss National Bank – have already started cutting rates.”

--With assistance from Andrew Atkinson.

(Updates with Andrew Bailey interview in sixth paragraph. An earlier version corrected the direction of market bets for BOE action in August.)

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