Former members of the central bank’s Monetary Policy Committee and other senior UK economists argue that the BOE’s current hawkish stance is out of step with both the economic outlook and peers in the US and the euro zone. The BOE is urged to provide new guidance with the next rate decision on Feb. 1, fearing that delaying this decision risks clashing with an expected general election later in the year.
The current guidance from the BOE has not changed since August, despite recent economic indicators showing a weakening of output, wages, and job creation. Inflation has fallen to 4%, and both the US Federal Reserve and European Central Bank have signaled potential rate cuts. Investors have already priced in significant rate cuts this year, posing a credibility threat to the BOE, which is perceived as being out of touch with market expectations.
The BOE is facing challenges in communicating a shift from its current guidance, preparing investors for potential rate cuts, and producing forecasts based on a market path that the MPC finds too optimistic about cuts. The bank is still perceived as very hawkish compared to its peers, making a pivot in messaging a more gradual process.
The markets have already priced in a reduction in borrowing costs this year, anticipating four quarter-point cuts in the benchmark rate to 4.25%, starting in June. This contrasts with the expectation just three months ago that rates would remain above 5% throughout 2024.
BOE Governor Andrew Bailey is urged to address these communication challenges promptly and avoid making the previous guidance seem inconsistent when the bank eventually pivots. Concerns are raised about public confidence in the institution, which is already at a record low.
Analysts suggest that Bailey could use the bank’s forecast to soften guidance by showing that unchanged rates would leave inflation well below the target two and three years out. Individual MPC members casting more dovish votes could also signal a shift in the bank’s stance.
The BOE’s current stance is considered particularly hawkish when compared to the European Central Bank, which has signaled a likely rate cut by summer, and the Federal Reserve, whose Chairman Jerome Powell has indicated the need for rate reductions before inflation drops to 2%.
Political factors, including an expected general election and potential tax cuts, may complicate the BOE’s policy decisions. While a general election is expected around November, an earlier vote could risk clashing with the BOE’s first rate cut.
The bank’s February decision will include new forecasts on growth based on market expectations for rates. However, tensions between the market path and the bank’s own analysis are evident, and there is a wider review of BOE forecasting being conducted by former Fed Chair Ben Bernanke, expected to report on his findings in March.
The BOE faced a similar communication problem in November 2022, and the tension between the market path and the bank’s own analysis raises concerns about the accuracy of forecasts, potentially showing higher inflation, faster growth, and lower unemployment than the MPC believes.
