After the Federal Reserve’s monster 0.5 percentage point cut in US borrowing costs on Wednesday, it seemed strange that the Bank of England should sit on its hands and keep interest rates on hold.
From a position earlier this year when the UK’s central bank was leading the way in cutting interest rates, it is now a laggard.
The European Central Bank is also ahead, having cut twice over the summer months, matching the half a point reduction made by the Fed.
Walking a different path, the Bank’s monetary policy committee (MPC) has kept interest rates on hold at 5%, which now ranks as the highest among major economies.
In more normal times, this stance would be seen in a positive light. High borrowing costs would be in place to calm an over-heating economy
Yet the UK is not overheating. Anything but. Economic growth remains stagnant and employment is well down from its pre-pandemic level. Businesses are not investing and consumer confidence, which rose earlier in the year, has stalled.
According to these measures, interest rates should be on the way down and at a much faster pace.
The MPC, or at least most of its nine members, says this analysis ignores important dynamics in the post-pandemic economy that are inflationary. It believes the jobs market remains stuck in a groove of ever higher wages that have yet to be choked off by high interest rates.
While the employment rate is down, this has not translated into unemployment going up by much. Instead, workers have bailed out of the labour market altogether. Some have joined the ranks of the long-term unemployed. These are working-age people who, in a previous era, were able to retrain and find a new job. Others have been signed off sick. Others have taken early retirement.
Without a thriving jobs market and a confident business sector keen to invest, the Bank judges growth will remain low and the economy unable to expand by much next year and the year after without being inflationary.
The MPC said: “Monetary policy will need to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further.”
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Financial markets are betting these words still allow for a further cut in interest rates this year to 4.75%, before a series of gradual steps down during 2025.
When inflation has fallen to within a whisker of the Bank’s 2% target – stable at 2.2% in July and August – and according to the latest assessment by the MPC, will only rise to 2.5% by the end of the year before falling back again, the case for cuts is clear.
What is also clear is that the Bank has closed its ears to calls for lower borrowing costs from mortgage holders and indebted businesses. They must suffer while the MPC follows a cautious path.