Bank of England Deputy Hints at Prolonged High Interest Rates

The Bank of England (BoE) appears poised to maintain elevated interest rates for an extended period as it continues to grapple with persistent inflation. Deputy Governor Clare Lombardelli informed lawmakers on Wednesday that price pressures across the economy are proving more resilient than initially projected.

Her statements suggested limited flexibility for the central bank to further reduce borrowing costs without risking a resurgence in inflation. Governor Andrew Bailey echoed Lombardelli's sentiments, reiterating that the BoE is unlikely to implement another rate cut in the near future. He noted that financial markets had comprehended the bank's warning that rate reductions would proceed more gradually than many had anticipated.

This cautionary stance marks a significant shift from just a few weeks prior when the bank lowered its base rate to 4.0% in August, following a contentious 5-4 split vote within the Monetary Policy Committee (MPC). The rate cut aimed to stimulate business activity amid indications of slowing economic growth and hiring. However, subsequent inflation data exceeded expectations, prompting policymakers to reassess their approach.

Rather than adhering to the previously expected quarterly rate cuts, as investors had predicted earlier in the summer, the BoE now suggests that rates may remain at their current level until well into 2026. This adjustment highlights the central bank's dilemma: While inflation has significantly decreased from its double-digit levels in 2022, it remains above the target and shows signs of persistence, particularly in sectors such as food, energy, and services.

Market Expectations Recalibrate

In his address to Parliament's Treasury Committee, Gov. Bailey asserted that his "message has resonated" with financial markets. He emphasized that while the trajectory for rates remained downward, the pace would be measured. Bailey informed MPs that there is now considerably more uncertainty regarding the extent and speed of the Bank's next moves.

Traders have scaled back their expectations for further cuts in 2025. Futures markets currently anticipate the first move in early 2026, likely in April. This represents a dramatic shift from earlier in the summer when bets were placed on at least one more cut this year.

Bailey highlighted ongoing concerns surrounding inflation and the labor market. He noted that the "risk of inflation has increased," although he remains more apprehensive than some colleagues about weakening employment trends.

Lombardelli reinforced this cautious outlook. She cautioned lawmakers that the current 4% rate might already be approaching the neutral level, below which inflation could potentially accelerate due to a tighter labor market and other factors.

Inflation continues to exceed the bank's 2% target significantly. It rose to 3.8% in July and is forecast to surpass 4% in September. Lombardelli warned that elevated food and energy prices were fueling inflation and influencing consumer expectations of future price increases.

In her written testimony, she noted indications that the disinflationary process was losing momentum, raising the risk of more prolonged inflation. She suggested that monetary policy may not even be substantially restrictive and, hinting at her potential reluctance to support further cuts, observed that historical evidence suggests the neutral rate could be at the upper end of the 2–4% range.

Committee Divisions on Future Action

The MPC remains divided. External member Megan Greene, known for her hawkish stance, supported Lombardelli's concerns over persistent inflation. In contrast, dovish rate-setter Alan Taylor warned that the greater risk lies in recession. He cautioned that gradual adjustments could potentially create self-perpetuating economic weakness.

Taylor also informed lawmakers that the current economic climate is unusually precarious, warning that if recessionary momentum builds, it could become increasingly difficult to reverse, based on historical precedents.

The bank maintains that rates will remain unchanged for now, indicating they will be held at 4% until at least the end of the year. Consequently, markets, businesses, and households are preparing for an extended period of higher interest rates.

The ongoing debate within the MPC reflects the complex currents coursing through the economy: cutting rates prematurely risks reigniting inflation, while maintaining high rates for too long could exacerbate an economic slowdown.