(Bloomberg) -- For most of the UK’s inflation shock over the past two years, Bank of England policy reacted to swings in wage and prices data. Now it’s leaning much more prominently on its own forecasts.
In a firm signal that noisy numbers won’t knock policymakers off their interest-rate-cutting path, they responded on Thursday to two large, surprise overshoots in pay and inflation outcomes earlier in the week with a “dovish hold” at 4.75%, as Capital Economics Deputy Chief UK Economist Ruth Gregory put it.
“We think a gradual approach to future interest-rate cuts remains right,” BOE Governor Andrew Bailey said.
Three members of Monetary Policy Committee voted for an immediate quarter-point move, five believed “recent developments added to the argument for gradual approach” to easing, and one – thought to be Catherine Mann – is poised to favor doing so aggressively in due course.
The panel squarely rejected traders’ analysis that inflation in the coming months will prove too persistent to allow further reductions in borrowing costs. Financial markets were certain of just one full rate cut next year in the immediate aftermath of the data, down from three a week earlier.
Instead, policymakers are now putting more weight on their view of the future, dismissing the surprise increase in private sector pay to 5.4% from 4.9% as a “volatile” indicator. Markets came back halfway after the vote, with two quarter-point reductions now fully expected in 2025.
For officials, sluggish growth since Labour’s tax-raising budget, and signs in their survey of businesses across the UK that the labor market is weakening, overrode the immediate data out-turns — a stance all the more striking in light of the US Federal Reserve’s refocus on price risks.
“There has been a scaling down of data dependence and more emphasis on the forecast,” said Michael Saunders, a former BOE rate-setter.
Dan Hanson, chief UK economist at Bloomberg Economics, said the MPC was “becoming less sensitive to data surprises and more forward-looking.”
Big Test
The shift formally took place in August when the BOE first cut its rate to 5% from 5.25% and dropped a specific focus on “labor market conditions, wage growth and services price inflation.” But December was the first big test after the data went the wrong way. Rather than respond cautiously, the BOE moved even more aggressively with three rate cutters. Economists had expected an 8-1 split to hold.
One of this month’s dissenters was Deputy Governor for Markets Dave Ramsden, who Saunders describes as a bellwether MPC member. Ramsden was an early mover on rate hikes at the start of the inflation shock, calling for an increase in November 2021. The rest followed a month later. In both February and September 2022 he voted for larger moves, which the rest subsequently backed. He then voted for a first quarter-point cut in May and June before colleagues joined him in August.
“He is more of an activist than the rest of the committee,” Saunders said. “The others will probably follow him in February.”
If the central bank is leaning harder on its forecast, it helps explain why Bailey said in an interview Thursday after the decision that he thinks “the path is downwards” and has endorsed the BOE’s November forecast for four quarter point cuts in 2025 to 3.75%.
“The central bank is becoming increasingly concerned about the economy and labor market,” Hanson said. The December minutes showed the MPC lowered its forecast for fourth-quarter gross domestic product to zero growth from an increase of 0.3%.
The BOE’s quarterly agents report found that employers plan to reduce headcount, hours and even to offshore jobs in response to the budget’s £26 billion ($32.6 billion) increase in employers’ National Insurance Contributions.
Some of that tax rise will be passed on in higher prices, but the survey found that businesses are “less confident of the extent and pace of recovery” next year since the budget.
“There was a common view that the UK was moving from a cost-of-living crisis period to higher cost of living and lower living standards being the ongoing norm,” the agents’ report said.
The missing piece is where the BOE believes rates will settle. The MPC minutes said the labor market is now “broadly in balance,” yet policy remains “restrictive.” Employment intentions point to “a very modest increase in employment over the next 12 months but have softened” since September, the agents’ survey said.
The implication is that the bank will actively be destroying jobs for as long as it maintains a “restrictive” stance. For that, it needs to have an estimate for the neutral rate — the level at which policy is no longer bearing down on the economy.
“They should be clear about where they think neutral is,” Saunders said. “You can’t decide how much you need to loosen if you don’t have that number.”
©2024 Bloomberg L.P.