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The Bank of England might begin cutting rates before inflation falls to its 2 per cent target, its governor said, as he pointed to “encouraging signs” that price pressures were easing.
Speaking to the Treasury select committee on Tuesday, Andrew Bailey said inflation had “come down very rapidly” in the UK, adding that the technical recession the economy entered last year is likely to be “very small”.
“We don’t need obviously inflation to come back to target before we cut interest rates,” Bailey said. “I must be very clear on that, that’s not necessary.”
The comments, which echoed similar remarks by the BoE’s chief economist Huw Pill earlier this month, came after the bank’s Monetary Policy Committee held its key rate at 5.25 per cent at its most recent meeting.
However, the central bank signalled then that it was ready to consider lowering rates for the first time since the Covid pandemic.
On Tuesday, Bailey declined to comment on when exactly the first rate cuts could come, or how deep they would be. But he said market expectations that the BoE was going to cut rates during this year were not “unreasonable”, adding: “I’m comfortable with a profile that has cuts in it, but that is not to say when or how much.”
Bailey told MPs that the BoE expected headline inflation to return to target temporarily in the spring before picking up again later in the year. He stressed that the bank wanted to ensure that inflation returned sustainably to target. “We are looking beyond that temporary period of being what we think will be down at target. We want to get it down and keep it down.”
UK government bonds led a global rally following Bailey’s comments. Interest rate sensitive 2-year gilt yields fell 0.07 percentage points to 4.55 per cent, while benchmark 10-year yields fell 0.06 percentage points to 4.05 per cent.
Traders in swaps markets moved to price at least three cuts by the end of the year, up from two or three cuts ahead of the hearing.
Earlier this month, new data from the Office for National Statistics showed that the UK slipped into a technical recession at the end of last year. Gross domestic product fell 0.3 per cent in the final three months of 2023, following a 0.1 per cent decline in the third quarter.
Bailey played down the significance of the figures on Tuesday, saying the UK economy was showing “distinct” signs of an upturn.
The BoE is focused on services price growth, wages and the health of the labour market as it looks for signs that inflation is on course to hit its 2 per cent target.
Bailey said he was looking for “more sustained progress on those three things”, but he struck an optimistic note about recent developments. “We have seen, I think, encouraging signs on them,” he said.
Ben Broadbent, a BoE deputy governor, said that services inflation and wage growth were still running at “probably almost twice the rate” consistent with stable 2 per cent inflation.
But he added that wages had been rising chiefly in response to higher living costs, with a tight labour market playing a lesser role. He said he was “reasonably confident” wage growth would edge down as consumer prices also began to stabilise and businesses became more cautious of trying to pass higher costs on to consumers.
Broadbent also defended the BoE’s record, saying that despite criticism of its forecasts and policy choices since the pandemic, the UK was now emerging from an inflationary surge much faster than in the 1970s.
The combined shock of the pandemic and Ukraine war had been around twice as big as the energy price shock of the 1970s, he argued, yet two years after the 1970s shock, inflation was still in double digits.
“This is nothing like that,” he said. “The reason is . . . ultimately it’s monetary policy and the credibility of monetary policy that determines the rate of inflation.”
Additional reporting by Mary McDougall
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