UK interest rates unchanged but inflation tipped to halve by May

The Bank of England has kept interest rates on hold as widely expected but has predicted that inflation could soon ease to 2%, though this might be short-lived.

In an announcement at noon today, it was confirmed the Bank’s Monetary Policy Committee (MPC) voted by a majority of 6–3 to maintain base rate at 5.25% – a 16-year high – in its first meeting of 2024.

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The vote split may raise a few eyebrows, with the three dissenters divided on which direction rates should go.

Two members of the MPC preferred a 0.25 percentage point rise to 5.5%, believing that tighter monetary policy is still necessary, despite inflation easing significantly since autumn. But interestingly, one member reckons it’s time to cut rates, voting for a 0.25 percentage point reduction to 5%.

When will rates come down?

The focus now is when rates will start to fall. But while the prospect has increased, we may have to wait some time with central banks on both sides of the Atlantic still wary about the threat that inflation poses.

In its February forecast, the MPC recognised that the risks to inflation are more balanced.

“Although services price inflation and wage growth have fallen by somewhat more than expected, key indicators of inflation persistence remain elevated,” the committee said.

The UK central bank’s decision to hold rates follows similar activity from both the European Central Bank (ECB) and US Federal Reserve (Fed). Yesterday the Fed kept rates in a benchmark range of 5.25% to 5.5% for the fourth meeting in a row, while last week the ECB held rates steady for the third time on the bounce.

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In today’s statement, the Bank said that the consumer prices index (CPI), the UK’s main measure of inflation, is projected to fall to the 2% target the first half of the 2024, albeit temporarily. The Bank expects price rises to speed up again in Q3, finishing the year at 2.75%.

The Bank said: “The committee has judged since last autumn that monetary policy needs to be restrictive for an extended period of time until the risk of inflation becoming embedded above the 2% target dissipates.”

Others are even more bullish on UK inflation, forecasting the Bank will overshoot its target this year which will lay the groundwork for significant rate cuts.

In a release published yesterday, Capital Economics said: “Our forecast that CPI inflation will fall below 1% later this year suggests the Bank Rate will be cut from 5.25% now to 3% rather than the low of 3.5-3.75% priced into the market.”

The International Monetary Fund (IMF) - an organisation that works with 190 member countries - predicts that rate cuts will arrive in the second half of the year.

Meanwhile, both the Fed and the ECB have struck a similarly hawkish tone to the UK central bank.

In a statement yesterday, the Federal Open Market Committee said that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%”.

The ECB has indicated that while its rate-hiking cycle is now well and truly over, looser monetary policy may have to wait a bit.

ECB president Christine Lagarde said on Tuesday: “if we have the option of either hiking or cutting, [it] will be a cut."

Largarde added: “There might be a hold, and hold, and a hold, and a hold, but the next move will be downward.”

What next for the UK economy?

The projected path of inflation will have a major influence on when rates will ultimately come down, but the economic outlook is also key.

Much of the talk in the lead up to this year’s Spring Budget, which will take place on 6 March, has centred on tax cuts. Jeremy Hunt is keen to cut taxes to boost economic growth, and seemingly sway voters with a general election looming, but the chancellor might have limited headroom.

Earlier this week the chancellor conceded that while he would like to lighten the burden for UK taxpayers, any giveaways must be done in a responsible way – perhaps wary of the economic ramifications caused by Kwasi Kwarteng’s ill-fated mini-Budget in September 2022, which included £45 billion of unfunded tax cuts.

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There is, however, a sense of déjà vu here. In the lead up to last year’s Autumn Statement, Hunt described tax cuts as “virtually impossible” yet took the axe to national insurance (NI) to support workers in a move that will cost £10 billion a year, according to the Treasury.

But it appears Hunt faces more resistance this time around. The IMF recently warned Hunt against tax cuts, suggesting it could inflict damage on the UK economy.

The outlook on these shores is less promising than in other parts of the world, according to the IMF. The organisation recently raised its forecast for global growth by 0.2 percentage points to 3.1%, largely due to improved prospects for the US, China, and other developed economies. However, the IMF expects the UK economy to grow just 0.6% in 2024.

Prospect of rate cuts offers hope to housing market

As central banks begin to warm to the prospect of rate cuts, this may offer some encouragement to homeowners and first-time buyers who have been hit hard by rising mortgage costs since the Bank began hiking rates in December 2021.

Borrowing rates have started to fall recently, due to a combination of possible rate cuts and the emergence of lender price wars.

And Bank of England data, published on Tuesday, has offered some green shoots to borrowers.

The data found that mortgage approvals for house purchases rose from 49,300 to 50,500 between November and December, while net approvals for remortgaging ticked up from 25,700 to 30,800 over the same period.

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What’s more, the “effective" interest rate (the actual interest paid) on newly drawn mortgages fell six percentage points to 5.28% in December. Importantly, this was the first drop since November 2021.

These developments are feeding through to the housing market.

According to data from Nationwide, UK’s largest building society, house prices rose 0.7% in January as falling mortgage rates begins to restore confidence to a market that struggled throughout 2023 in the face of higher borrowing costs.

And Nationwide recently applied major cuts to some mortgage products, launching a five-year fixed deal at 3.84% for new remortgaging customers.