There was no doubt in the City that the Bank of England would hold interest rates at 4.75%. A spurt in annual inflation last month and a sharp rise in wages in the autumn meant its monetary policy committee (MPC) was widely expected to hold fire on a third rate cut this year.
What many will find more surprising is the yawning gap between the six committee members who voted to hold rates and the three who voted for a reduction.
Those who voted to do nothing, including the governor, Andrew Bailey; the chief economist, Huw Pill; and the head of monetary policy, Clare Lombardelli, cited threats to the Bank’s mandate of keeping inflation to a 2% target, namely the jump in October’s wages growth above 5% and an inflation rate that has risen over three consecutive months to 2.6% at the last count.
They are also concerned about the long-term constraints on the labour market from high levels of sickness and ill health, which appear to be denying employers the skilled workers they need and forcing them to pay higher wages – not just this year, but maybe for many years to come.
Higher wages have the effect of feeding into inflation over the next two years if businesses can convince consumers that they need to take the pain of higher production costs. A persistent rise in wages above inflation will also increase demand for goods across the high street, encouraging retailers to raise prices even further.
On the other side of the debate are the dovish three, who see through the current wages and inflation data to the state of the economy and how it is faring after Labour’s first budget.
They are concerned about the Bank’s assessment of economic growth in the fourth quarter, which officials have downgraded from 0.3% to zero. This can be read as a thumbs down on Labour’s aspirations that its November budget would boost growth.
Yet an ailing economy needs a lift from somewhere, and that could come from lower borrowing costs. You might say that is the central bank’s job.
Then there is a view that the recent rise in wages still relates to the cost-of-living crisis and the efforts of workers to claw back some of the losses from a three-year period that has added more than 20% to average prices.
At the moment, the wage rises shifting the average higher are mostly in the gift of the government from successive increases in the minimum wage. Bonuses in the NHS are also feeding through into the wages data and bumping up average incomes – a factor that will be excluded in the new year.
Then there is the savings rate, which has edged up over the last year and shows that many households are not spending whatever disposable income they have acquired through higher wages, but squirrelling much of it away.
Maybe the uncertainty before and after the budget has influenced their thinking. Perhaps the threat of higher taxes, such as a 5% increase in council tax next April, is preventing consumers from opening their purses and wallets.
Whatever their reason, there is the possibility that predictions of zero growth in the fourth quarter turn negative next year and recession looms unless someone is prepared to take decisive action.
If the dovish argument holds sway at the next MPC meeting in February 2025, a cut to 4.5% is likely, though markets were giving a 55% probability of a hold on Thursday afternoon.
Will there be many more reductions in the cost of borrowing next year? Investors say not. They do not expect a recession and are betting on just one more reduction to 4.25% by the end of the year. That scenario pitches the UK into another period of stagnation, undermining the government’s attempts to drive the economy forward.
