Andrew Bailey faces a trickier than expected call on interest rates

Given the modest turbulence in UK debt and currency markets that followed the Budget this week’s interest rate decision has become trickier than was expected. The Bank of England risks being dragged into an arena it hates to be - politics. If it decides to cut interest rates the Bank risks accusations of being in the pocket of a government already worried about high interest rates. By contrast should the Bank hold policy rates unchanged it risks further volatility in the cost of UK government borrowing. It is an unenviable choice for an independent central bank.

A look back at the previous forecasts from the Bank of England

Back in August - the last time the Bank of England published its forecast for the UK economy and delivered its first rate cut of the year - Bank staff foresaw inflation averaging just 1.8% in 2026. At less than the Bank’s 2% target this forecast provided the basis for lowering UK borrowing costs. Since that date, inflation has come in better than the Bank expected. The current UK inflation rate of just 1.7% a year sees consumer prices rising rather slower than the 2.1% the Bank forecast. This data had briefly moved markets to expect an acceleration in the pace of interest rate cuts with Governor, Andrew Bailey, fueling these expectations with his own comments in early October.

This data and associated commentary were before markets had the full knowledge of a Budget with more expansionary public sector spending plans. The Office for Budget Responsibility - after considering the government’s Budget measures - now see inflation averaging 2.3% in 2026. If Bank staff agree with this inflationary impact of increased public spending, then several members of the Monetary Policy Committee will find it hard to make a convincing case for an immediate to cut to UK interest rates.

A decision on UK interest rates awaits

The job for Governor Bailey is made harder by the fact that he will be chairing a split Committee. Whilst it is to be welcomed that there isn’t groupthink amongst UK policymakers, any political criticism becomes very personal to the Governor if he is again – like he was in August – required to deliver the casting vote. August’s rate cut was pushed through on a 5-4 vote. A similarly tight vote is possible again this week. There are a significant number of members on the rate-setting Committee who are publicly concerned that even before the Budget UK core inflation - stripping out the volatile energy and food components - remains uncomfortably high. Those concerns will have only been amplified by the inflationary risk of public sector actively competing with the private sector for scarce resources over the next couple of years.

The timing is not just challenging because of the UK Budget. There is the small matter of a contentious US election on Tuesday, and a highly likely interest rate cut from the US Federal Reserve later in the week. Whilst not directly relevant for UK domestic price pressures, the path for the US Dollar sets important inflationary context given the scale of Dollar-denominated imports into the UK economy. Most notable amongst these impacts is the cost of energy imports. One of the reasons why last week’s turbulence on UK markets was not as acute as after the Mini Budget was that in 2022 a strong US Dollar and spiking energy prices amplified UK inflation fears. A becalmed US backdrop is far from certain by the end of this week.

Whilst on the subject of the Mini Budget, the role performed by the Bank of England around that infamous event continues to bug supporters of former Prime Minister, Liz Truss. Specifically, the Bank’s announcement the day before the Mini Budget to begin sale of its holdings in UK government debt. The last thing Governor Bailey will want at this time is to again be seen as a character in a Westminster psychodrama. The Bank’s sale of UK government debt continues apace – at a rate of £100bn/ year – and sticking to that path despite last week’s spike in government debt interest will be seen as an important test of the Bank’s independence.

And this is probably where the biggest test lies for the Bank this week - affirming that additional spending by the government won’t be allowed to go unchecked into higher UK prices. Nothing would be more damaging for the Bank’s credibility. There are already high-profile US investors such Stanley Druckenmiller and Paul Tudor Jones speculating that governments around the world have lost their fiscal disciple - and suspecting that central banks will indulge them with a tolerance of higher inflation. These investors are placing billions of dollars’ worth of bets that government debt will become less valuable over the coming years. Druckenmiller has form in taking on the Bank of England - having played a pivotal role alongside George Soros in the Black Wednesday crash of the Pound in September 1992.

So how does the Bank of England navigate this minefield of risk? Well it probably can justify a November interest rate cut on the grounds that recent inflation data has undershot expectations. Bank policymakers can also suggest that they are still working through the implications of the Budget announcements. This would be a fair disclaimer. I have heard from a lot of UK businesses in recent days each reporting a mix of inflationary and disinflationary implications of the Budget. So it will take time for the Bank to establish the economy-wide impact. But one thing is for certain, when Chancellor Rachel Reeves thanked Governor Bailey shortly into her Budget speech last week she meant it. A skillful navigation of the next few days by the Bank will be worth its weight in gold to the Government.

This article was first published in The Times. 

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