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Goldman Sachs expects the Bank of England to cut interest rates more aggressively than financial markets anticipate.
The US investment bank argued that Bank Rate would fall to as low as 2.75 per cent by November next year, whereas it had previously expected the terminal rate to be three per cent.
Markets think the terminal rate will potentially be as high as 3.5 per cent.
The updated forecast came after Goldman published a revised estimate of R*, the Goldilocks interest rate at which the economy is at full employment and inflation is at two per cent.
It suggested that R* had increased to 0.7 per cent from 0.4 per cent during the pandemic, discounting the impact of inflation.
This means it would be around 2.75 per cent including two per cent inflation.
“R* typically increases with productivity growth, population growth and public debt, but falls with the relative price of capital and inequality,” Goldman said.
Despite the increase in R* the analysts noted that Bank Rate still remains “notably restrictive,” meaning interest rates are weighing on economic activity.
“Together with rapidly falling inflation and dovish MPC commentary – (our findings) reinforces our view that the BoE will ultimately lower rates more than priced,” the analysts wrote in a note.
The Bank of England cut interest rates for the first time since the pandemic in August and although rate-setters paused last month, they are expected to lower rates again in November.
The odds of another rate cut in December increased last week after new figures showed that inflation fell to 1.7 per cent in September, below expectations.
Deutsche Bank also published new rate projections on Monday. Like Goldman, Deutsche Bank pointed to evidence that the neutral rate had increased.
The analysts expected the Bank to cut rates in two separate stages, with Bank Rate falling to 3.75 per cent by next May – at the top end of their R* estimate – before policymakers switch to quarterly cuts. They expect the Bank Rate to fall all the way to three per cent.