Bailey says ‘too early’ to think about rate cuts in rift with Bank’s chief economist

Andrew Bailey has said it is “too early to be talking about cutting rates” in a sign of a rift at the Bank of England between the Governor and the Chief Economist.

Mr Bailey said the Monetary Policy Committee (MPC) was “very clear” that it was not focused on possible interest rate cuts and dismissed market bets on reductions by the middle of next year.

He said: “The market of course will reach a view, it has to reach a view on the future path of interest rates, I totally understand that. But we are very clear we are not talking about that.

“It is really too early to be talking about cutting rates”.

The comments come days after Huw Pill, the Bank’s chief economist, said it was “not unreasonable” for investors to bet on a rate cut by next summer, assuming there is no change in the trajectory of the economy.

He predicted the base rate would stay at or around the current level of 5.25pc “into the middle of next year” but added: “It is at that point you might consider or reassess, if nothing new has happened, where we are going to have to be.

“That’s what financial markets currently anticipate, but it doesn’t seem totally unreasonable, at least to me.”

Bond markets rallied following Mr Pill’s words. However, the caution from the Governor stemmed the rise in debt markets. Yields on two-year gilts, which move inversely to price, rose following Mr Bailey’s comments.

Speaking at an event in Dublin, the Governor struck a more hawkish tone than Mr Pill.

He said: “Policy is going to have to be restrictive for an extended period.

“There are still some upside risks to policy – the terrible events of the Middle East haven’t actually so far caused a rise, in particular, in the oil price but it is obviously a risk.”

His caution came even as the price of Brent oil dropped more than 2pc on Wednesday to a two-month low of just below $80 a barrel. Crude prices have dropped sharply in recent days amid concerns about growth in China and receding fears about the Israel-Hamas war’s impact on the market.

Inflation should fall to the Bank’s 2pc target in the next two years “but we have got to continue doing the work to make that happen”, Mr Bailey told the Central Bank of Ireland’s Financial Systems Conference.

Markets believe the Bank has now finished its cycle of rate increases and will look to cut next year.

Analysts at UBS expect the Bank to cut rates to 4.25pc by the end of next year and 2.5pc by the end of 2025.

However, Mr Bailey was keen to talk up the possibility of more rate increases at the latest MPC meeting last week. Three members of the nine person committee voted for another increase in borrowing costs to 5.5pc, though the rate was held at 5.25pc.

Speaking on Wednesday, the Governor said there were still pressures in the jobs market that risked supporting inflation.

He pointed to a fall in the share of the working-age population who are in work or looking for work, suggesting this bolstered the case for keeping rates high.

Although playing down the chance of rate cuts in the near future, Mr Bailey said demographics meant interest rates were likely to return to low levels in future.

He said: “It is really about ageing populations, the fact that we all tend to save more as we get older, the interest rate is the price of money so it is balancing savings and investment, and in an older population there tends to be a larger amount of saving compared to the demand for investment.

“That tends to suggest we will go back to something lower.”

Economists at PwC expect the ageing population to push interest rates as low as 1pc in the years ahead.

Analysts said in a report published on Thursday: “Demographic ageing is close to an inevitability for the advanced economies. It also seems reasonable to assume that productivity growth will remain modest, unless there are significant structural changes to the UK economy.

“For these reasons, it is our view that the medium to longer-term level of nominal interest rates is likely to be closer to its pre-pandemic level (in the range of 1-3pc) than its current level of around 5pc.”

PwC also predicted that inflation would drop firmly below 5pc by the end of the year, meaning the Prime Minister will meet his promise to halve inflation by the end of this year.

As inflation comes under control, there are growing risks to the economic outlook from high interest rates and still-painful energy prices.

Mario Draghi, former president of the European Central Bank, predicted recession in the eurozone.

Mr Draghi, who was also Prime Minister of Italy, told a Financial Times conference: “It is almost sure we are going to have a recession by the year-end. It is quite clear the first two quarters of next year will show that.”

Mixed messages at Bank of England as fears grow Bailey risks doing too much to fight inflation

The Governor has a history of clashing with colleagues – and making costly mistakes in the process

As inflation spiralled ever higher in 2022, the Bank of England was largely united.

A broad agreement among policymakers emerged that interest rates must rise as officials sought to show they were serious about getting inflation under control.

Now, the situation has changed.

With interest rates at 5.25pc and inflation on the way down, economists and financial markets are confident the Bank has done enough to get prices back under control.

But there is no clear agreement on what to do from here. Policymakers are divided over when to start lowering rates and how fast to bring them down.

At the MPC’s most recent meeting last week, three members of the nine-person committee voted for rates to go higher, backing a move to 5.5pc. Catherine Mann, perhaps the most hawkish member of the committee, has suggested it is better to risk rates going too high and cutting them sharply if needed.

Swati Dhingra, meanwhile, has consistently voted to stop rate rises since last November.

Hints of division spilled out into the open again on Wednesday when Governor Andrew Bailey said it was “really too early to be talking about cutting rates”. The comment came days after his colleague, the Bank’s chief economist Huw Pill, appeared to do just that.

Members of the Monetary Policy Committee (MPC) are going off-script as the Bank enters a new phase in the fight against inflation.

Pill’s comments hinting at a diversion from Bailey’s view are the most significant signal of the debate going on within the MPC.

It recalls the disagreement between Bailey and Andy Haldane on inflation in early 2021.

In February 2021, then chief economist Haldane warned that complacency risked letting the “inflation tiger” out of the bag. From May that year onwards, he started voting for an early end to quantitative easing – the programme of money printing that some have argued fuelled price rises.

After Haldane left the MPC later that year, fellow hawks Michael Saunders and then Dave Ramsden took on his unsuccessful campaign to stop printing money to buy bonds as inflation was rising.

Bailey, meanwhile, argued that inflation was transitory. In July 2021 he said it was important not to “overreact” to rising prices.

Haldane was subsequently proved right and Bailey wrong. The miscalculation proved costly to Bailey’s credibility.

Now, however, some fear the Governor will repeat the same mistake. After being too slow to cotton on to the brewing inflation crisis in Britain’s economy, there are concerns he and others on the MPC may now be too slow to realise inflation has been quashed.

While inflation remains at 6.7pc, Pill believes it will fall rapidly in the coming months to levels seen elsewhere in Western economies. Inflation has fallen to 3.7pc in the US and 2.9pc in the eurozone.

In June, outgoing MPC member Silvana Tenreyro warned of the risk of “over tightening”.

In an effort to restore credibility and prove they can get a handle on inflation, there are fears Bailey and his allies risk doing unnecessary damage to the economy by keeping borrowing costs higher than they need to be.

Pill’s hints at possible rate cuts by the middle of next year suggest not all agree with Bailey’s determination to stay the course on higher rates for longer. The uncertainty this introduces risks undermining the firm line Bailey wishes to take.

This may be the point: if more dovish members of the MPC fear interest rate rises have gone too far, then raising hopes of an early rate cut can help take the edge off the pain faced by borrowers and the wider economy.

Communication is a powerful tool in the armoury of central bankers and it is possible to talk down markets by suggesting interest rate cuts are in the post.

Bond prices rallied in the wake of Pill’s comments this week, bringing down borrowing costs for governments and banks.

Pill and Bailey were on the same page last week when both voted to hold interest rates unchanged at 5.25pc. Consensus may prove harder to maintain as the inflation battle enters its next phase.