The Bank of England has determined to maintain interest rates at 5% and announced its plans to reduce its reserve of UK government bonds by a further £100 billion in the next year, placing a strain on public coffers. The decision was made by the monetary policy committee in an 8-1 vote, with the only dissenting voice being Swati Dhingra, an external committee member, who pushed for a further quarter-point rate cut after last month saw the first decrease in borrowing costs since 2020.
Economic experts, surveyed by Reuters, had predicted a 7-2 vote in favour of maintaining the current rate, following the contentious 5-4 decision to reduce rates last month from an enduring 16-year peak. Coinciding with this announcement was the Federal Reserve’s decision to reduce US interest rates by half a percent, reflecting confidence in diminishing inflation pressure.
However, the Bank of England adopted a more careful approach. Andrew Bailey, Governor of the Bank of England, mentioned the lessening inflationary pressure as a sign that the bank should be able to reduce interest rates in a steady manner. However, he also cautioned against any sharp reductions, emphasising the need to maintain low inflation.
Market observers believe that the UK’s central bank will implement slower rate cuts than the Fed in the coming year due to sustained inflationary pressures in the UK market. The Bank of England has projected a rise in annual consumer price inflation to approximately 2.5% by the year’s end, up from 2.2%. The forecast, lower than an earlier 2.75%, is due to dropping oil prices.
Before this decision, market players had anticipated approximately five quarterly-point rate reductions by June 2025. This mirrored the forecast for the European Central Bank, though it has already made two cuts this year. Comparatively, seven rate cuts are expected in the US, notwithstanding the more aggressive approach adopted on Wednesday.
Quantitative tightening, the reversal of the previous policy of buying hundreds of billions of UK government bonds to stimulate the economy, was unanimously supported by the monetary policy committee. This will not only see the bonds mature but also be actively sold, with the process set to continue at its current pace for the year until October 2025. This decision was widely expected by the bond market.
The Bank of England has maintained its tightening pace of £100 billion, mirroring last year’s programme, and meeting market anticipations. Some stakeholders forecasted a faster Quantitative Tightening (QT) as the Bank currently holds bonds worth £87 billion that will naturally mature over the subsequent year, leaving roughly £13 billion for proactive bond sales at the current speed.
Nonetheless, several parliamentarians and research-based institutions have criticised the QT process, as the bank realises forward losses it had incurred from purchasing government bonds at significantly higher rates than their existing value. These bonds are backed by taxpayers, adding to the concern. The bank also suffers losses on interest paid on the reserves used to fund these bond purchases, with the interest significantly exceeding generated returns.
Economic scholars propose that Rachel Reeves, the newly appointed Chancellor of the Exchequer, may alter the UK’s financial regulations to disregard the effect of the Bank of England’s QT scheme on her first budget, scheduled for October 30th. This could potentially provide her with extra fiscal capacity amounting to several billion pounds.
Despite criticism, the Bank of England sustains the belief that the QT process is running without significant disruptions, exerting only a slight influence on the overall monetary policy. It defended the QT regime’s use as necessary to prevent an excessive increase in its bond holdings, thereby ensuring its ability to react flexibly during future financial crises.