By William Schomberg, David Milliken and Suban Abdulla
LONDON (Reuters) -The Bank of England took another step towards lowering interest rates, as a second official backed a cut and Governor Andrew Bailey said more could be on the way than investors expect.
The BoE said on Thursday its Monetary Policy Committee voted 7-2 to keep rates at a 16-year high of 5.25% after Deputy Governor Dave Ramsden joined Swati Dhingra in voting for a cut to 5%.
Economists polled by Reuters had mostly expected another 8-1 split to keep rates on hold.
Sterling dropped against the dollar and the euro after the announcement while British government bond yields fell sharply as investors added to their bets on the BoE rate cuts ahead.
Bailey told a news conference it was possible that the BoE would need to cut rates by more than the market expected. The BoE’s next policy decision is on June 20.
“Let me be clear, a change in Bank Rate in June is neither ruled out nor a fait accompli,” Bailey said.
The MPC has now kept rates on hold at six meetings in a row. A first cut since March 2020 – at the onset of the COVID-19 pandemic – could offer a potential boost for Prime Minister Rishi Sunak.
He has told voters that the economy is turning a corner but is struggling to reduce the opposition Labour Party’s big opinion poll lead before an election later this year.
The BoE added a line to its post-meeting statement, saying it would be watching the next rounds of economic data closely.
“The Committee will consider forthcoming data releases and how these inform the assessment that the risks for inflation persistence are receding,” the BoE said.
“On that basis, the Committee will keep under review for how long Bank Rate should be maintained at its current level.”
Paul Dales, chief UK economist at Capital Economics, said the BoE had given the impression it was getting closer to cutting rates. “We think some soft inflation and wages data may be enough to prompt it to cut rates at the next meeting in June, if not at the following meeting in August,” Dales said.
Hetal Mehta, head of economic research at St. James’s Place, said the BoE might have a long wait for confirmation that inflation is moderating. “Any expectations of a rate cut in June would be premature as base effects will only temporarily get inflation down to target,” she said
Over a nearly two-year period from late 2021, the BoE – like other central banks – pushed up borrowing costs to tackle a surge in inflation which peaked at 11.1% in October 2022.
Since then, headline inflation has fallen back and the BoE expects it slowed to around its 2% target in April, largely because of falling energy prices.
But the BoE has remained on guard because of still-strong wage growth and services price inflation which threaten to push inflation back above 2%.
Bailey said the news on inflation had been encouraging.
“We need to see more evidence that inflation will stay low before we can cut interest rates,” he said in a statement. “I’m optimistic that things are moving in the right direction.”
The pound fell by about a third of a cent against the U.S. dollar immediately after the BoE’s decision and statements were published and the yield on two-year British government bonds, which are most sensitive to BoE rate speculation, fell by 3 basis points.
Financial markets fully priced in a first quarter-point BoE rate cut by August and see another in November or December taking Bank Rate to 4.75%, followed by more cuts in 2025.
JUNE CUT?
Investors have been trying to work out whether the BoE is likely to cut rates in June – when the European Central Bank has already signalled it will reduce borrowing costs – or, like the U.S. Federal Reserve, will hold out for longer.
On Wednesday, Sweden’s central bank cut its key interest rate for the first time in eight years.
The BoE sent a fresh message to investors that their bets on rate cuts might be too conservative as it cut its inflation forecasts for two and three years’ time to 1.9% and 1.6% – below its 2% target – from its February projections of 2.3% and 1.9%.
The BoE’s inflation forecasts partly reflect market interest rate expectations in the run-up to its MPC meetings, which now predict fewer cuts this year than in February.
Minutes of the BoE’s May meeting showed differences between the seven MPC members who voted to keep rates on hold around how persistent inflation pressures would be, and how much more evidence of a slowdown was needed to justify a rate cut.
Ramsden and Dhingra said a cut was needed now because of the time lag in monetary policy decisions impacting the economy and because inflation might fall more than the BoE had forecast.
The MPC’s decision to stress the importance of “forthcoming data releases” will add to the focus on the two official labour market reports and the two sets of inflation figures which are due before its next scheduled announcement on June 20.
Wage growth and services price inflation of around 6% remain higher than in the United States or euro zone, even though British economic growth is more sluggish.
The BoE slightly lifted its growth forecasts for Britain’s economy, saying it expected 0.5% growth in gross domestic product over 2024, up from 0.25% in its February forecast.
It also said a recession in the second half of 2023 had probably ended, offering some relief to Sunak and the Conservative Party as they battle to turn around the opinion polls.