After a long period of high inflation, the Bank of England finally has its 2 per cent inflation target firmly in its sights.
The central bank said Thursday that inflation is expected to reach the target within two years and then decline further as authorities inch toward lowering interest rates.
The majority of the bank’s nine-person rate-setting committee voted this week to keep rates at 5.25 percent, the highest since early 2018 and where they have been for nine months. But two members voted in favor of cutting rates, compared to just one at the previous meeting in March. And Andrew Bailey, the bank’s governor, reiterated that rate cuts are most likely.
“We need to see more evidence that inflation will remain low before we can lower interest rates,” Bailey said in a statement. “I’m optimistic and I think things are going in the right direction.”
For much of the next year and a half, the bank expects inflation to be around 2.5 percent. But inflation will fall to 1.9 percent in early 2026, the bank predicts, and to 1.6 percent in three years. Although inflation has receded sharply from its recent peak, when it surpassed 11 percent in late 2022, the central bank is wary of declaring victory prematurely.
Like many other central banks, the Bank of England is trying to find the delicate balance between cutting interest rates as inflation slows towards its targets and not easing monetary policy too much because of the risk of a resurgence of inflationary pressures.
The United States has provided a possible warning. The Federal Reserve is expected to delay rate cuts as data shows price pressures are still strong in the United States. In March, consumer prices rose 3.5 percent from a year earlier, more than economists had expected. But confidence is growing across Europe that high inflation has dissipated and that rate cuts could support the weak economy. On Wednesday, Sweden’s central bank cut rates and European Central Bank officials have said they expect to do the same next month.
Britain finds itself in a difficult situation somewhere in between. When April’s inflation reading is released in two weeks, it is expected to show price growth slowing to the central bank’s 2 percent target due to the effect of lower household energy bills. That would be down from 3.2 percent in March. But the Bank of England is acting cautiously.
Some aspects of inflation are still relatively hot. Both average annual wage growth and services inflation were 6 percent. This figure is still too high for some policymakers to feel confident that inflation will slow sustainably to 2 percent.
“We haven’t beaten inflation yet,” said Tera Allas, director of research and economics at McKinsey’s Britain and Ireland office and a former civil service economist. Although inflation will fall further this year, she said, she expected it to be “really volatile.”
“We will enter something similar to the situation in the United States, where there is no longer a clear line” of lower inflation, Allas said. “There will be ups and downs, ups and downs, but I suspect at a lower level than in the United States”
Investors have recently been betting that the Bank of England would cut rates in August and again before the end of the year.
All this will occur in a context of mediocre economic growth. The central bank forecasts the British economy will expand just 0.5 percent this year and 1 percent next. Much of the increase is due to a growing population. At the same time, consumer spending is expected to support economic growth as average wages rise faster than inflation and employment levels remain relatively strong, the bank said. But other factors will weigh on the economy, such as limited public spending and high interest rates that discourage investment and credit.
On Thursday, the National Institute for Economic and Social Research said it expected the central bank to wait until August to start cutting rates, and then lower rates once again this year and twice next year, gradually lowering after that. until the rate is set at 3.25. percent.
Paula Bejarano Carbó, an associate economist at the institute, said caution among central bankers was “reasonable” given that there were still risks of inflation rising due to pressures on prices from, for example, the services sector.