Bank of England's long unwinding road: Mike Dolan
LONDON - An expected cut that will take the Bank of England's key interest rate to 4% this week will be merciful relief for an economy badly in need of a lift. But overwhelming caution and a split among policymakers mean the easing cycle is set to be one of the shallowest and most drawn out in modern history.
The BoE, like its central bank peers, has had a torrid five years, but with numerous home-grown twists and turns to boot.
With Brexit just kicking in, the COVID-19 pandemic hit in 2020 - forcing massive BoE balance sheet support for government rescues during the lockdowns. A supply shock from the post-pandemic reboot combined with massive monetary and fiscal stimulus to sow the first double-digit UK inflation spike in over 40 years - exacerbated by soaring energy costs after Russia invaded Ukraine in March 2022 and complicated by a government-inspired bond market blowout later that year.
The scramble to hike borrowing costs ensued as early as 2021 and the BoE has only slowly pared them back over the past year.
And inflation is still not sustainably back to its 2% target, U.S. trade barriers are now rising sharply and policymakers and investors alike are struggling to determine exactly what the new normal is.
Given this backdrop, the central bank's recent mantra of 'gradual and careful' seems reasonable.
Deutsche Bank economists Sanjay Raja and Shreyas Gopal sought to quantify that caution this week by pointing out that the slow and shallow BoE easing cycle so far is already the third-longest since World War Two.
If their forecast for the BoE's official bank rate - of four-quarter-percentage point cuts to 3.25% by next February - turns out correct, then this easing cycle will be the longest since 1945. What's more, they calculate that no rate-cut cycle that's lasted more than two quarters has delivered less easing than the current one.
The Deutsche team reckon this is all consistent with the central bank's 'softly softly' guidance, but is also likely a "reflection of a very divided MPC (Monetary Policy Committee) following four years of above-target inflation."
BoE policymakers broke three ways back in May when the central bank last cut rates - with votes for the majority decision, a deeper cut and no change - and some think that split could re-emerge this week.
GROPING IN THE DARK
Financial market pricing chimes with Deutsche's take and tentatively prices a "terminal rate" for the cycle at about 3.25%, paring back less than half the hikes that took the rate from the near-zero level to 5.25% during the 2021-2023 period. And that's a quarter-percentage-point higher than where markets think the U.S. Federal Reserve's policy rate will end up late next year.
If the BoE policy rate does settle there, it would be a quarter percentage point above the average of the past 28 years of the central bank's operational independence - perhaps the clearest reflection of the big structural hit to both the domestic and global economies in recent years.
But as the policymaker split is watched closely again on Thursday alongside the BoE's updated economic forecasts, some banks - such as Morgan Stanley - still assume the bank rate will eventually be eased much further to 2.75% by the end of 2026.
To get there, the BoE will likely have to grope around in the dark a bit longer.
In a speech last month, BoE policymaker Alan Taylor outlined his thoughts on the fabled "r-star" neutral real interest rate, the theoretical rate that neither spurs nor drags on economic activity and prices.
His work suggested that a British r-star is now around 0.75%, which, after adding a 2% inflation rate, would imply that a BoE policy rate of 2.75% is indeed a reasonable landing point.
That estimate hasn't changed much in 10 years, even though it's less than half of what it was on the eve of the 2007-2008 global banking crash.
Indeed, Taylor underscored the very long-term trend of declining neutral rates in his presentation by highlighting a vast data set of interest rates from around the world clearly showing that interest rates had not just been falling steadily for the past 50 years, but the past 800 years.
And yet even a BoE dove like Taylor knows how foggy it still is out there at the moment, especially given this year's expected UK inflation rebound and still punchy wage gains.
"Optimism has faded and geoeconomic storms have blown in," he said before concluding on a philosophical note, "We know we will never see the end of the road, but we must always be looking for it."
Central bankers everywhere may be trying to do just that, though few are likely seeing anything clearly right now.
The opinions expressed here are those of the author, a columnist for Reuters
-- Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global financial commentary. Follow ROI on LinkedIn. Plus, sign up for my weekday newsletter, Morning Bid U.S.
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