The Bank of England said the UK faces a stagnating economy and persistent inflation, as it kept interest rates at a 15-year high and warned that policy will stay tight “for an extended period of time”.
On a day that the BoE voted to hold rates at 5.25 per cent for the second successive meeting, its forecast highlights the challenge for the UK economy and for Prime Minister Rishi Sunak as he heads into an election year.
The central bank said growth would remain “well below historical averages” over the medium term, even as its forecasts signalled that inflation is set to remain more persistent than it previously expected.
BoE governor Andrew Bailey said the Monetary Policy Committee would be watching “closely” to see if further rate rises were needed, adding: “It’s much too early to be thinking about rate cuts.”
The MPC voted six to three to keep its benchmark rate unchanged, in line with expectations. A minority of members sought a further quarter-point increase.
The central bank is treading a delicate line as it seeks to beat inflation while not pushing a weakening UK economy into an outright recession in 2024, expected to be an election year.
UK interest rates are at their highest since the financial crisis, with the bank weighing evidence of weak growth against consumer price inflation of 6.7 per cent.
The BoE now expects growth to be flat in the third quarter, weaker than previously expected, with only a 0.1 per cent expansion in the final three months of the year.
It anticipates that output will remain stagnant throughout 2024, with a significant risk of outright contraction.
The downbeat picture reflects the pressure imposed by the central bank’s 14 rate rises since December 2021, with BoE staff estimating that only about half of the impact on gross domestic product has been felt to date.
The BoE forecast also suggests the UK government will hit its goal of halving inflation by the end of the year but that inflation will only drop below the bank’s 2 per cent target at the end of 2025.
It now expects inflation of 3.1 per cent in the final quarter of 2024, higher than previously predicted, before inflation drops to 1.9 per cent in the final quarter of the following year.
Chancellor Jeremy Hunt said after the BoE’s forecasts were published that the UK economy had been “far more resilient than many expected”.
But the BoE’s gloomy growth predictions contrast with a more upbeat assessment in the US, where Federal Reserve chair Jay Powell this week highlighted the resilience of the country’s economy.
Thursday’s MPC vote came after similar decisions to keep rates on hold by the Fed on Wednesday and the European Central Bank last week. Those stances have bolstered investors’ confidence that the global rate-rise cycle may have reached its peak.
Swaps markets are pricing in the first BoE cut for August or September next year.
London’s benchmark FTSE 100 and the mid-cap FTSE 250 closed up 1.4 per cent and 3.4 per cent, respectively, with interest rate-sensitive real estate groups among the biggest winners.
Bailey said that the committee would rely on future data to balance the risks “between doing too little and doing too much”. But he stressed the MPC had not discussed the notion of cutting rates.
The IMF has forecast that UK inflation will hover above the rates in other G7 countries this year and next, underlining the central bank’s struggle to get to grips with inflation.
The BoE warned that risks to the inflation outlook remained “skewed to the upside”. Among the threats are an escalation of the Israel-Gaza conflict, which could further push up energy prices.
Sterling edged higher after the BoE’s announcement before falling back to trade up 0.2 per cent against the dollar at $1.22.
Two-year gilt yields, which move in line with interest rate expectations, fell 0.06 percentage points as global markets pared back expectations of future rate rises.
The shifts came as investors piled into US and European government debt on expectations of a possible end to the rate-rise cycle that has hammered the bond market for more than a year.
In one of the biggest drops in borrowing costs since Silicon Valley Bank’s failure in March, investors pushed down the yield for 10-year US Treasuries, a benchmark for global asset prices, by more than 0.3 percentage points in two days.
Government bond markets also rallied across Europe.
Additional reporting by George Steer and Mary McDougall