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If Insights: Will UK cut its interest rate ahead of US?

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The United Kingdom's March inflation report confirmed investor confidence that the BoE's policymakers, will choose to reduce interest rates early in 2024 to accelerate economic development

The United Kingdom’s recent economic health may have made it possible for the Bank of England (BoE) to begin lowering interest rates in 2024, at least a section of the analysts believe.

The cheer is not an unfounded one as food prices showed a decline in March 2024, which further caused the overall inflation to reach its lowest point in 2.5 years. According to the Office for National Statistics (ONS), consumer prices in the United Kingdom increased by 3.2% in the year that ended in March, the smallest increase since September 2021, after declining by 3.4% in the previous two months.

The United Kingdom’s March inflation report confirmed investor confidence that the BoE’s policymakers, under Governor Andrew Bailey’s direction, will choose to reduce interest rates early in 2024 to accelerate economic development. Analysts noted that although UK inflation remains higher than the BoE’s 2%, the trend is downward.

The United Kingdom has raised expectations for a rate cut. Fed Chair Jerome Powell issued a warning last week about the possibility that interest rates in the largest economy in the world may remain elevated for some time due to an unexpected increase in price pressures in the US.

Worry Still Lingers

As per the International Monetary Fund (IMF), UK GDP will grow by just 0.5% in 2024. However, with falling inflation and predicted interest rate cuts, it looks like the Rishi Sunak government may be taking the British economy out of the woods to some extent.

However, the projected growth figures are not that encouraging, as IMF sees the ratio to stay around 0.1% points for 2024 and 0.5% and 1.5% in 2025. IMF also sees the calculated per head GDP, which measures the monetary value of goods and services produced within Britain, will flatline in 2024.

However, with inflation also falling faster than previously expected and interest rate cuts on the way, the overall economy may be in a healthier shape by the 2024 end. Not a bad turnaround, because the European country went into recession at the end of 2023. IMF sees the UK economy to outmuscle Germany, France and Italy from 2025 onwards. IMF also sees the Bank of England lowering interest rates from the current headline rate of 5.25% and providing much-needed relief to homeowners facing sharp rises in mortgage rates.

A sharp downturn in inflation and interest rates is made possible by what the IMF says has been a ‘rapid fading’ of the price shocks caused by Russia’s war on Ukraine. However, the British economy is still facing headwinds like persistently slow economic growth, high public debt and little room to increase government spending.

UK Inflation: Essential Measures

Core inflation, which does not include energy, food, drink, or tobacco, decreased to 4.2% last month from 4.5% in the previous month, which was also more than economists had predicted. In the meantime, the BoE’s indicator of domestically generated pricing pressures, the services sector’s inflation, dropped from 6.1% to 6%. Economists and the BOE had projected a decline of 5.8%.

UK traders dramatically reduced their bets on the BoE cutting interest rates, shifting their preferences to only one quarter-point cut this year. Following the announcement of the UK inflation figures earlier today, sterling climbed against the euro and touched a new one-month high against the declining dollar.

Following the release of the data, the pound saw a 0.4% increase to USD 1.2479, ending a three-day losing streak. In one of the most policy-sensitive bond markets, the yield on two-year gilts, increased by as much as six basis points to 4.53%, the highest level since February. The end of 2022 saw a high of almost 11% for UK consumer price index-based inflation due to the Russian invasion of Ukraine, which sharply increased energy prices.

Will UK announce rate decreases before the US?

For the first time in the past two years, the UK’s inflation rate is lower than the US’s. The US saw an increase in inflation to 3.5% in March. BoE Governor Andrew Bailey noted that the inflation dynamics in the two economies are different and suggested that the UK would be able to cut interest rates before the US.

Andrew Bailey said that due to the latest robust US price data rattling markets, there is more demand-driven inflation pressure in the US than there is in the UK. He observed strong evidence of a reduction in price pressures in the UK.

According to his comments, Andrew Bailey doesn’t think there’s much chance that the UK will have upward inflation, as it happened in the US in March.

In stark contrast to Andrew Bailey’s remarks, Fed Chair Jerome Powell stated that new inflation statistics suggested it would take more time for US officials to feel confident enough to cut interest rates.

Economists predict that UK inflation will drop even further in April 2024, probably to less than 2%, as a result of much lower domestic energy costs. This could lead BoE policymakers to contemplate lowering interest rates in the coming months.

According to reports, analysts anticipate decreases from the BoE of 41 basis points (bps) in 2024. Global inflation has decreased in part because higher interest rates make borrowing more expensive, which cools the economy and reduces expenditure.

Here’s How Rate Reductions Will Help Households

Experts cautioned against the BoE using a lower-than-anticipated decline in inflation in March as justification for delaying future interest rate reductions. BoE decision-makers must remain composed and take initiative. Analysts believe that the central bank should take swift, clear action this summer.

“We hope that excessively cautious authorities won’t use this as just another excuse to further postpone rate cuts, even though the last stretch to meeting the BoE’s 2% target is harder and slower. Starting in June, they have to start lowering the historically high rate of 5.25%. No ifs, no buts,” declared deVere Group CEO Nigel Green.

“It (BoE) cannot fail now with its dedication to a restrictive monetary policy, which is making matters worse for consumers and businesses throughout the United Kingdom,” Green stated.

A rate reduction will have a large positive impact on households because lower mortgage rates result in lower monthly payments, which free up extra cash for savings and spending. Reduced financing costs increase the accessibility of homeownership for prospective purchasers, hence boosting demand for homes.

The analyst continued, “A rate drop would boost consumer confidence and expenditure, pushing economic development from the ground up by relieving financial burdens on people.”

The Discussion In America

President of the Federal Reserve Bank of Atlanta Raphael Bostic stated that he was satisfied with maintaining current interest rates and reiterated that he believes lowering borrowing costs won’t be acceptable until close to the 2024 end.

Bostic stated that although he still thinks inflation will reach the central bank’s 2% target, it would probably do it more slowly than most people anticipate. The head of the Atlanta Fed has already stated that he expects this year to see just one rate drop.

Bostic, who will vote on monetary policy this year, stated he will keep an eye on inflation-adjusted wage increases and employment creation.

“At the moment, our current stance—which I believe is restrictive—will slow down the economy and finally get us down to 2%. However, if all these other wonderful things are occurring, I’m not in a crazy rush to get there,” the official commented further.

After inflation showed itself to be obstinate in the first three months of the year, policymakers are prepared to maintain interest rates at their present, two-decade high. Fed Chair Jerome Powell stated that sustained inflation indicates it will probably take longer than anticipated to build sufficient confidence to reduce borrowing prices.

Traders now anticipate one or two rate reductions this year. That is a long cry from the three that Fed officials penciled in just a month ago, and the roughly six that they anticipated at the beginning of 2024.

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