Bank of England should be wary of further interest rate cuts: Alastair Morley
With markets pricing in interest rate cuts on both sides of the Atlantic this year, central bankers may be tempted to ease quickly, and hope inflation behaves.
The European Central Bank looks set to hold the line. But the Federal Reserve may not, and that matters for the UK. Looser-than-expected US policy is unlikely to stay contained. History suggests such events tend to lift UK growth and inflation simultaneously. That alone strengthens the case for caution from the Bank of England.
This is the moment when long-standing norms, or “rules of thumb”, for setting interest rates matter most. Rates held meaningfully above inflation give the Bank of England ratesetters the flexibility to respond to shocks such as energy price rises, geopolitical events or looser monetary policy abroad, without losing control of inflation at home.
When the Base Rate was lifted to a 15-year high of 5.25 per cent in mid-2023, it marked a dramatic reversal after more than a decade of low-rates policy. But the damage had already been done. For the 15 years following the global financial crisis the base rate sat, on average, almost two percentage points below inflation, a radical departure from historical norms. Between 1989 and 2007, base rate was consistently held above inflation, helping to anchor prices and protect savers’ purchasing power.
The consequences of abandoning those norms have been laid bare after the pandemic. Supply chain disruption, energy shocks and geopolitical instability all played their part, but inflation does not surge to 11 per cent in a vacuum. Ultra-low rates and £450bn of bond purchases left prices with plenty of room to run.
There is another, less discussed cost of holding rates too low for too long: it leaves policymakers with nowhere to go. Monetary policy only works when it can move in both directions. The Bank of England kept a heavy foot on the accelerator by cutting rates close to zero. When inflation spiked, it had to jump on the brakes and sent shockwaves through household finances.
Now the base rate sits above inflation again, but only just. The gap remains smaller than historical norms and raises legitimate concerns that cutting too far, too fast risks repeating old mistakes. If inflation is to settle sustainably at 2 per cent, policy must remain meaningfully restrictive, not politically convenient.
Nowhere is this difference clearer than in savings. Despite strong competition and an expanding range of products, many savers continue to lose ground. Savings rates have lagged inflation, delivering negative real returns for much of the last 15 years. That is the inevitable result of a policy that prioritised cheap borrowing over fair returns. If savers are still losing out while competition is intense, it is a sign base rate remains too low.
Markets are increasingly alert to the risk that US monetary policy could loosen faster than inflation warrants, increasing the risk of persistent inflation in the UK. Wage growth has repeatedly surprised to the positive, and the Bank of England has admitted its inflation forecasts have “proved repeatedly too low”. When an error runs consistently one way, caution should win over confidence.
As global monetary policy turns, the Bank of England faces a choice. Speed and short-term relief or balance, credibility and long-term stability.
Alastair Morley is Editor of INTEREST by Moneyfacts.