Monetary policy is the only game in town to help to revive the short-run fortunes of the ailing UK economy, but the Bank of England is unwilling to pull the lever.
The UK-US trade deal will mask the government’s disappointment that the central bank is not playing its part in Labour’s growth strategy.
Despite cutting interest rates as expected to a two-year low of 4.25 per cent on Thursday, the Bank’s rate-setters are still not convinced of the need to carry out significant monetary easing to help to cushion the blow from global uncertainty.
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That is despite its internal forecasts showing that tariffs will shave 0.3 percentage points off economic growth over three years and will slow consumer price inflation by 0.2 percentage points. These are dynamics that should tip the central bank into a clear easing mode.
MPC divided
After years of criticism over its “groupthink”, the nine-strong monetary policy committee is in its most divided period since being set up in 1997. The committee has not delivered a unanimous vote in any of the seven decisions since it began cutting interest rates last August.
At the latest meeting, a slim majority of five voted to reduce borrowing costs by a quarter of a percentage point — a cohort that included the governor Andrew Bailey and his two deputy governors. Within this group, three voters said they were only swayed to favour a rate cut due to rising tariff uncertainty. Bailey admitted that he was one of the “undecideds” in this camp.
On the flip side, two doveish members — Swati Dhingra and Alan Taylor — think the economy needs a larger dose of stimulus, and argued for a half-point cut. Huw Pill, the Bank’s chief economist, and Catherine Mann, an external member, voted for no change to keep the base rate at 4.5 per cent.
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Rather than groupthink, the MPC is now at risk of doublespeak. For most of this year the Bank has said it will cut interest rates at a “careful and gradual” pace. This was before President Trump threw a grenade into the global trading system, with a US tariff rate of 145 per cent on China and the threat of sweeping import taxes on the rest of the world after a 90-day pause that ends in July.
Tariff noise has already knocked the wind out of British consumers and businesses, with surveys showing a sharp drop-off in sentiment in April. Private sector activity contracted for the first time since 2022 last month and consumers, who have been engaging in precautionary saving, are likely to become more reluctant to spend windfalls from rising wages.
Other central banks in Canada and the eurozone have responded with a clearer commitment to looser monetary policy in response to Trump-induced uncertainty. The Bank is refusing to follow course, insisting that it will stick with the incremental interest rate cuts it promised before Trump’s “liberation day” tariffs announcement. The fact that two rate-setters opted not to cut rates at all will add to the hawkish dynamic. Financial markets had been expecting at least three more reductions this year.
Andrew Bailey, governor of the Bank of England, was among those to vote for a quarter-point cut
KIN CHEUNG/REUTERS
Inflation risks
The Bank justified its reticence in setting out a clear rate-cutting path by pointing to the danger of inflation spiralling out of control again this year. Rate-setters are now worried that the temporary spike in consumer prices this summer, caused by higher utility and administered prices, may not be temporary after all. Consumer price inflation is on course to peak at 3.5 per cent later this year, up from the current 2.8 per cent and lower than the 3.75 per cent the Bank forecast earlier this year. Inflation is on course to fall to the 2 per cent target by the first part of 2027, six months earlier than its last forecast.
Despite faster disinflation, the committee thinks there is a risk that inflation may become semi-permanent if Britons — who have been scarred by years of rising prices — demand higher wages and companies use the jump as another excuse to raise their consumer prices. This will create dangerous second-round effects that will keep inflation far above the Bank’s 2 per cent target for at least another year.
The Bank has pointed to the recent upward drift in household inflation expectations as a reason to worry about inflation becoming sticky rather than transitory. Clare Lombardelli, the Bank’s deputy governor for monetary policy, told reporters this was not the Bank’s “base case” but rater-setters were closely watching surveys for signs of persistent inflation fears in areas such as food prices and energy. She said the Bank did not yet have evidence that companies were planning to lift prices in response to higher inflation later this year.
Trade
Two thirds of the 0.3 per cent downward revision to the UK’s GDP over the next three years is the result of the indirect consequences of US tariffs. This is made up of uncertainty hitting businesses and consumers, volatility in financial markets, and the impact of retaliatory tariffs imposed by other countries, with the UK caught in the crossfire.
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The Bank’s forecasts for growth and inflation are predicated on a the US applying a minimum 10 per cent tariff on all imports from the UK and other trading partners staying in place. The forecast was produced before the news of the government’s trade deal with Washington.
Bailey welcomed the “excellent” UK-US trade agreement and said it could have a bigger impact on the economy if it is followed up by more pacts to reduce tariffs.
He said a thawing in US-China relations would be more important in reducing uncertainty in the UK after Washington and Beijing imposed levies of more than 100 per cent on one another. The two sides will meet for trade talks in Geneva this weekend.