Title of the Article Bank of England cuts interest rates to 5% in first reduction since March 2020
Source of the Article
Reuters https://www.reuters.com/markets/rates-bonds/bank-england-cut s-rates-16-year-high-careful-future-moves-2024-08-01/
Date of the Article
August 1, 2024
Date of Commentary 28th August 2024
Word Count
Unit of the syllabus that relates to the article
Macroeconomics
Key Concept
Economic well-being
Bank of England cuts rates from 16-year high, 'careful' on future moves
By Reuters
August 1, 20246:26 AM CDTUpdated 3 months ago A view of the Bank of England building, in London, Britain, July 3, 2024. REUTERS/Maja Smiejkowska/File Photo Purchase Licensing Rights opens new tab
By David Milliken, Andy Bruce, and Suban Abdulla
LONDON, Aug 1 (Reuters) - The Bank of England cut interest rates from a 16-year high on Thursday after a narrow vote in favor of policymakers divided over whether inflation pressures had eased sufficiently. Governor Andrew Bailey - who led the 5-4 decision to lower rates by a quarter-point to 5%
- said the BoE's Monetary Policy Committee would move cautiously going forward.
Advertisement · Scroll to continue
Report this ad "We need to make sure inflation stays low, and be careful not to cut interest rates too quickly or by too much," he said in a statement alongside the decision.
Thursday's decision was in line with the forecast in a Reuters poll of economists but financial markets had only seen just over a 60% chance of a cut.
Rates have been on hold for almost a full year - the longest period rates have been left unchanged at the peak of a BoE tightening cycle since 2001 - and this is the first cut in rates since March 2020, at the start of the COVID-19 pandemic. Advertisement · Scroll to continue
In June, the BoE voted 7-2 to keep rates on hold, and minutes of the most recent meeting showed the decision to cut rates had been "finely balanced" for some members - echoing the language used previously when rates were kept unchanged.
None of the policymakers who changed their vote at this meeting - Governor Andrew
Bailey and Deputy Governors Sarah Breeden and Clare Lombardelli - had spoken publicly about monetary policy since the BoE's last meeting in June.
Speaking opportunities had been limited by an election campaign that ended on July 4, which brought the Labour Party to power with a large majority.
The BoE said policymakers had been briefed on the government's public sector pay and fiscal policy announcements this week, but their impact would only be incorporated into the BoE's forecasts after the Oct. 30 budget. British consumer price inflation returned to the BoE's 2% target in May and stayed there in June, down from a 41-year high of 11.1% struck in October 2022.
This leaves British inflation lower than in the eurozone - where the European Central Bank cut rates in June - and the United States, where on Wednesday, the Federal Reserve kept interest rates steady but opened the door to a September cut.
INFLATION TO RISE However, the BoE expects headline inflation to rise to 2.75% in the final quarter of the year as the effect of last year's steep falls in energy prices fades before returning to its 2% target in early 2026 and later sinking below.
The long-time lags for interest rates to affect inflation mean the BoE is more focused on what it sees as medium-term drivers of inflation: services prices, wage growth, and more general tightness in the labor market.
Services inflation came in well above the BoE's forecasts in June, but the BoE put this down to "volatile components" and regulated prices that were influenced by high headline CPI earlier in the year. Wage growth at nearly 6% is almost double the rate the BoE views as consistent with 2% inflation but is slowing in line with the central bank's expectations. The BoE now thinks Britain's economy will expand by around 1.25% this year, revised up from its previous forecast of 0.5%, reflecting stronger-than-expected growth during the first half of this year. Unemployment will rise slightly as high interest rates continue to bear down on growth, the forecasts showed, reducing upward pressure on inflation.
However, the BoE acknowledged the risk that inflation pressures might prove more persistent and keep inflation above target for longer than its main forecast. Before the meeting, financial markets priced in two quarter-point cuts by the BoE this year.
The BoE forecasts were based on market expectations, which show interest rates falling to about 3.7% by the end of 2026. Next month, the BoE will also need to decide whether it will continue the 100 billion pound a year reduction in its bond holdings built up between 2009 and 2020. In its report on Thursday, the BoE stuck with its assessment that these sales had a limited impact on the gilt market and that the high level of interest rates gave it scope to fine-tune monetary conditions if the impact proved greater in the future. The BoE estimated that its bond sales had contributed 0.1-0.2 percentage points to a 2.75 percentage point rise in 10-year gilt yields between February 2022 and June 2024.
Commentary The article discusses the decision by the Bank of England to cut interest rates from a 16-year high. This decision was made after a narrow vote by policymakers (5-4) as they were divided over whether inflation pressure had eased sufficiently. The interest rate was reduced by a quarter point to attain 5%. The decision to cut interest rates is a contractionary monetary policy aimed at inflationary pressure that resulted from expansionary policies that were implemented after the coronavirus pandemic. The measure has been taken to ease inflation from a 41-year high of 11.1% that struck in October 2022. The key concept discussed in this commentary is economic well-being. The Bank of England is focusing on protecting the country's economic well-being. The Bank of England has been fighting inflation using expansionary monetary policy, and the policies have been successful.
Inflation in the UK Economy Figure 1 is an illustration of the UK economy after the government used expansionary monetary and fiscal policy after the effects of the COVID-19 pandemic. The world economy was affected and the policies used led to a rise in inflation. The UK government used policies that led to growth in aggregate demand from AD to AD1. The overall price of goods and services in the economy increased from P1 to P2. The UK economy grew from Y1 to Y2. These policies led to an increase in inflation to 11.1% in October 2022. Since then, the UK government has been focusing on curbing the growth of inflation and increasing interest rates with the aim of increasing the cost of borrowing. Consequently, the flow of money was reduced, and the level of inflation started falling significantly. Although the MPC was split by five votes to four, it is evident that many of the members are aware that higher interest rates had serious impacts on economic growth. By cutting the interest rates, the central bank tries to reduce the cost of borrowing, hence stimulating investment and consumption. This may result in the fueling of economic activities and employment and may also smoothen the deleterious impact of economic downturns. This move reflects a proactive response to the impending economic challenges and securing financial stability.
The effects of hiking interest rates
Figure 2 illustrates the current state of the UK economy and what warrants the reduction of interest rates. Higher interest rates lead to increased borrowing costs, which discourages borrowing for both individuals and firms in the private sector. Economic growth reduces from Y2 to Y1 because the aggregate demand falls from AD1 to AD2. Prices reduced from P2 to P1. Consequently, lower economic growth may cause a recession. The UK government's intervention by cutting the interest rate to 5% will reverse this reaction in the economy. This policy will benefit the consumers who are individual borrowers. This is because they will borrow more for consumption. Besides, businesses will borrow more and invest, creating job opportunities in the UK economy. The multiplier effect will help multiply wealth in the UK, leading to improved standards of living for residents. The aggregate demand will increase, as illustrated in Figure 1, and hence, the economy will be expected to expand significantly. Consumers and mortgage owners will benefit from this policy because they will pay less and, hence, retain more income. Lower interest rates will promote spending and investment because there will be no benefit in saving.
Although this policy will effectively bring greater economic well-being, there are many limitations and risks involved with such interventions. While low interest rates are appealing in the short run, they have unavoidable consequences in terms of asset bubbles, increasing household debts, and reduced incentive to work for fiscal prudence. Admittedly, this policy might be limited beyond the Bank of England by exogenous factors such as disruption in global supply chains or emerging geopolitical tensions. In the long term, the intervention may lead to insight into the very problem of inflation, and therefore, there is a need to balance it with other policies that balance out the effect.
The recent cut in the interest rate by the Bank of England underlines how crucial government intervention is in managing continuous economic challenges and maintaining economic well-being. While such actions are essential to keep instability at bay and grow economies and businesses, they have to be finely calibrated, keeping short-term imperatives in mind with long-term sustainability. Navigating such intricacies of an advanced global economy, the interplay between state interventionism and market forces shall thrive.
