The Time May Be Now for BOE to Claim Inflation Victory

The Bank of England meets today to decide if today's the day policy makers ease monetary policy after an aggressive tightening cycle, and the views on whether or not it cuts rates are split.

The BOE is at a juncture where it can claim victory on inflation while having room to maneuver by cutting rates without immediately triggering higher inflation. There's a lot at stake -- namely high mortgage rates and squeezed consumers who are coming off their lower fixed rates soon.

The BOE beat the ECB and Fed in raising rates in December 2021 (followed by the Fed in March 2022 and the ECB in July 2022). Currently, the real policy rate is at 3.25% for the UK, compared to 1.75% for the euro area and 2.50% for the Fed.

A positive real rate indicates that the central bank’s policy rate, after adjusting for inflation, results in a positive yield, allowing the BOE to support the economy by making borrowing cheaper while still maintaining control over inflation.

UK inflation has eased from double digits a year ago to the central bank’s 2% target, and unemployment has risen. The latest PMI readings showed moderating cost pressures, driven by slowing output prices in the services industry, where much of the stickiness in consumer inflation is currently seen.

The BOE has the scope to cut rates and be the first to claim it has successfully navigated the smoothest tightening cycle to meet the 2% target among its peers. This would be a significant victory.

However, the window to claim such a victory is akin to a honeymoon, and those don’t tend to last long. Should the BOE wait too long, it risks seeing inflation rise again due to factors beyond its domestic control, squeezing consumers further and potentially falling behind the curve.

The UK generally imports more than it exports—not just goods and energy, but inflation too. As of Q4 2022, more than 70% of headline CPI was due to external pressures, according to Swati Dhingra last year, the MPC’s most dovish member.

What does that mean for the pound? Well, its declines so far today have already halved its year-to-date gains. And there are headwinds no matter what the BOE does. Should the bank ease policy, it will do so because officials are convinced that the fight to tame inflation has been successful. That would suggest that they’ll be much more dovish than markets currently expect. But any hold today could see the lagged impact of earlier tightening weighing on the economy and hurting the pound.

A reading shelf from my Bloomberg News colleagues on this:

• The BOE Shouldn't Set Its Own Speed Limit: Marcus Ashworth
• BOE Tilted Toward First Rate Cut Since Pandemic: Decision Guide
• BOE’s Asset Sales Are Set to Become Bigger Headache for Treasury

And be sure to tune into Markets Today -- Bloomberg's flagship UK live blog -- for a blow-by-blow analysis. Usual caveats -- all views here are mine, and are not investment advice.