BoE holds rates amid heightened uncertainty while ECB continues cutting rates

Bank of England

The BoE’s decision to keep rates on hold was widely expected, maintaining a 50-basis-point reduction from their multi-decade high of 5.25%. In its accompanying statement, the BoE reiterated its guidance that “monetary policy would need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term had dissipated further.” BoE Governor Andrew Bailey emphasized, “We think a gradual approach to future interest rate cuts remains right,” but cautioned that the economy’s uncertain outlook makes it difficult to plot an exact path for interest rates.

Leading up to the meeting, data showed headline inflation had climbed to an eight-month high of 2.6%, with services inflation remaining at 5.0%, a key concern for policymakers. Average weekly earnings also rose 5.2% in the three months ending in October, unexpectedly accelerating from the previous month’s reading of 4.90%, ending a steady deceleration seen since mid-2023. However, the latest read on the economy showed that GDP contracted in both September and October, fueling concerns about stagflation if high borrowing costs persist alongside rising unemployment. The accompanying statement revealed that the BoE now predict zero growth for the fourth quarter, a weaker outlook than their November forecast. The statement also highlighted that inflation, global trade policy, and geopolitical risks had “increased materially,” partly influenced by U.S. President-elect Donald Trump’s election victory.

Markets initially reacted by pushing short-term U.K. interest rates higher, but traders later adjusted, betting on earlier and steeper BoE rate cuts, driving yields lower approximately five basis points lower on the day. The GBP also declined ~50 basis points from its pre-meeting highs.

European Central Bank

The ECB lowered borrowing costs for the fourth time this year, lowering rates by 25 basis points to 3%, delivering a more dovish message. President Christine Lagarde highlighted stronger than expected third-quarter growth but maintained a cautious outlook due to challenges from global policies, domestic politics, and economic momentum. President Lagarde noted that while some policymakers proposed a larger 50-basis-point cut, the final decision to cut by 25 basis points was unanimous.

ECB staff projects GDP growth at 0.7% in 2024, 1.1% in 2025, and 1.4% in 2026. Inflation forecasts indicate an average of 2.4% for 2024, dropping to 2.1% in 2025 and 1.9% by 2026. From the reaction in interest rate swaps markets, the signaling of further rate cuts was in line with investor expectations, with the forward curve largely unchanged after the decision. Markets are pricing in five more 25-basis-point cuts by next September, which would take the deposit rate to 1.75%. Lagarde stressed that the ECB was not on a preset course, acknowledging that they still need to be mindful of lingering inflation risks that will determine the pace of cuts at each meeting.

Moving forward

Longer-term government borrowing costs have moved higher over the past few weeks, as investors demand increased term premiums for holding government paper for longer, suggesting that investors are less confident about central banks getting inflation back to target — requiring higher rates for longer — or are more concerned about the current and future levels of government borrowing. Either way, it’s not ideal for the cost of U.K. debt to increase when the economy appears to be stalling. The BoE now has to balance the risk of tipping the economy into a recession by keeping rates higher for longer or risking inflationary pressures by cutting rates.

The ECB’s outlook suggests a steady path toward neutral interest rates, projected between 1.75% and 2.5%. However, ECB growth forecasts may be overly optimistic, given rising political challenges both at home and abroad. The self-imposed fiscal rules constrain the ability of governments to boost growth through additional borrowing, which means that the ECB will tackle economic stabilization through easier monetary policy. Markets anticipate additional rate cuts, and it seems the ECB will deliver. Preventing another recession will depend partly on America’s trade policy in the coming months, as well as the political instability in Germany and France.