The Bank of England (BoE) is anticipated to keep interest rates unchanged, following the lead of the European Central Bank (ECB) and the Federal Reserve. Futures markets suggest that the Bank Rate will remain at 5.25%, which is the highest level since March 2008. While the focus is on the BoE's accompanying statement and economic projections, the question remains as to when rate cuts could potentially begin.

Similar to its counterparts in the United States and the eurozone, the BoE has been grappling with inflation over the past few years. In response to annual consumer price increases that exceeded 11% in October 2022 due to rising energy costs and COVID-related supply disruptions, the BoE delivered 14 interest rate hikes. Although headline CPI inflation has since decreased significantly, dropping to 4% in December, it still remains double the BoE's 2% target.

This inflationary environment would typically lead to a more hawkish stance from the central bank. However, the poor state of the UK economy complicates matters. The November Monetary Policy Report by the BoE's Monetary Policy Committee predicts "broadly flat" GDP growth in the fourth quarter of 2023 and in the foreseeable future. It also suggests that CPI inflation is likely to return to the 2% target by 2025.

Unfortunately, recent data has been even worse than anticipated by the BoE. Sanjay Raja, senior economist at Deutsche Bank, notes that GDP growth, wage growth, and inflation have all fallen short of the MPC's November forecasts.

Despite these challenges, bond yields have decreased, and expectations for interest rate cuts have been priced in for the coming years. This adjustment may ultimately lead to higher long-term growth than previously projected.

Given these circumstances, it is likely that the MPC will maintain a negative outlook for 2024 while raising its economic growth forecasts for the coming years.

Economic Outlook and Interest Rate Forecasts

Goldman Sachs predicts that the growth projections for the years 2025 and 2026 will be revised upward. This revision is due to the updated conditioning path for the Bank Rate. The Bank Rate is expected to decrease by an average of 85 basis points over the forecast horizon. This projection is based on the November Monetary Policy Report (MPR).

Furthermore, Goldman Sachs believes that the Bank of England (BoE) will lower its near-term inflation forecasts. This adjustment is attributed to softer consumption data and lower energy prices. The Consumer Price Index (CPI) is expected to reach 2% by the end of this year as a result. Consequently, there may be an opportunity for interest rates to be cut by the spring.

Goldman Sachs maintains its position that the first 25 basis point cut will occur in May. Subsequently, they predict 25 basis point cuts at every meeting until the Bank Rate reaches 3% in May 2025. Although not ruling out an earlier cut in March, especially if there is a further deterioration in growth, Goldman Sachs suggests May as the likely timeframe for the first rate cut.

Societe Generale economist Sam Cartwright agrees with this assessment. Cartwright believes that the decline in both pay growth and inflation strengthens the case for a rate cut in May.

However, Cartwright raises a concern that the impact of the National Living Wage increase on pay growth may not be apparent until after the May meeting. Therefore, it may encourage the BoE to delay the rate cut slightly.

Overall, as long as there are no unexpected inflation shocks, markets should soon witness the easing of monetary policy that they are anticipating.

According to interest rate futures trading on ICE, market indicators suggest that the Bank Rate will decline to 4.4% by December 2024 and further decrease to 3.45% a year later.

Daiwa Capital Markets states that the BoE's Monetary Policy Committee (MPC) should adjust its guidance in the next statement. They suggest that the MPC should drop its rate-hike bias and acknowledge that, based on their projections, the next change in rates is likely to be a decrease.

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