The Bank of England’s decision to leave interest rates on hold this week was no surprise. However, there is still little sign that policymakers are thinking of cutting rates any time soon, despite stagnant growth and falling inflation. Indeed, three of the nine members of the Monetary Policy Committee (MPC) voted again for another quarter point hike.

The tone of the accompanying statement was hawkish too, implying that interest rates are likely to need to remain high for an extended period, and even that more tightening in monetary policy may be required.

This tough stance will be hard for many struggling families and businesses to swallow, but it is not difficult to explain. The MPC’s remit, set by the Chancellor, is to keep consumer price inflation at 2 per cent at all times. Unfortunately, headline inflation was still 4.6 per cent in October, and the core rate (excluding food and energy) was even higher, at 5.7 per cent.

The remit does allow for some flexibility in response to temporary shocks, if the economic or financial costs of bringing inflation rapidly back to target would be too great. But the essential points are that the MPC’s main job is to worry about inflation, not growth, and that inflation is still far too high.

Nonetheless, there is a clear danger that the Bank will keep its key short-term interest rate higher for longer than is either necessary or desirable. The MPC is also persisting with its policy of selling back the government bonds it bought earlier under ‘quantitative easing’. (Bank officials deny that this ‘quantitative tightening’ is having a significant impact on the yields on these bonds, and hence on longer-term interest rates more generally, but it surely must have some effect.)

This is risky. Almost every leading indicator of inflation is pointing firmly downwards, including money and credit, producer prices, and global energy costs.

The Bank’s fears about a ‘wage-price spiral’ are also overdone. In reality, wages are only catching up gradually with prices, and there is already evidence that pay pressures are easing.

The MPC does see the near-10 per cent increase in the National Living Wage (NLW) in April as a new threat. But this increase at least meets the Government’s promise to raise the NLW to two-thirds of median earnings by 2024, so should be the last big increase for a while. In the meantime, long-term expectations for inflation remain well behaved, and the labour market is cooling.

Alas, the MPC currently lacks the confidence or the credibility to cut interest rates until it is certain that inflation is back under control. By then, it may be too late to prevent a prolonged slump.

Hopefully, though, inflation will continue to surprise on the downside in the New Year, allowing the Bank of England to join other central banks in loosening policy again. And even if the Bank is reluctant to act, the markets may still come to the rescue.

UK government bond yields and the cost of fixed-rate mortgages are already falling as investors start to anticipate big cuts in global interest rates in 2024, led by the US Fed. This should ease some of the headwinds for the UK economy, regardless of what the Bank itself does.

What’s more, it will be easier for the Bank of England to cut interest rates without further undermining credibility if other central banks are doing the same. And the Bank’s hand may be forced anyway by the currency markets if UK interest rates remain much higher for longer. This is because sterling could become too strong for comfort.

The upshot is that interest rate cuts are coming. The MPC may still have a bias towards further tightening, but the markets are surely right to take little notice.

This article was first published by the i newspaper on 14 December 2023

• Applied economics
• Everyday Economics
• financial markets
• Monetary policy
• UK economy