Bank of England Rate Decision: QE Tapering Expected Amid Bond Market Volatility

Bank of England's Upcoming Decision and Its Impact on Monetary Policy

The Bank of England (BoE) is scheduled to announce its interest rate decision on Thursday, with widespread expectations of keeping the benchmark rate unchanged. However, the focus is particularly on how the bank will handle its quantitative tightening (QT) program in light of the increasing volatility in the government bond market.

Expectations for a Slower Pace of Quantitative Tightening

Forecasts suggest that the BoE will reduce the size of its annual reduction in government bond holdings from £100 billion to approximately £70 billion. In addition, the bank may impose restrictions on the size of long-term government bond sales.

Interest Rates and Inflation

While the Monetary Policy Committee (MPC) is widely expected to keep the benchmark interest rate at 4%, persistent inflation at elevated levels could eliminate any hopes for another rate cut in 2025. This contrasts with the Federal Reserve's recent decision to cut interest rates for the first time since last December and plans for two more cuts this year.

Caution Regarding Future Interest Rate Cuts

Economists expect the MPC to remain cautious about any further interest rate cuts. In August, the committee reiterated that it would follow a "gradual and prudent strategy" and warned that further rate cuts "will depend on how sustained the easing of underlying deflationary pressures is." Since August, the key rate has been lowered cumulatively by five times (25 basis points each time), and the restrictiveness of monetary policy has been reduced.

MPC Voting Dynamics

The MPC is expected to vote 7-2 to keep interest rates unchanged, as policymakers are still waiting for signals of a "clear decline in underlying inflationary pressures" in the labor market. Alan Taylor and Swati Dingra, both long-time supporters of loose monetary policy, are most likely to support a more flexible monetary policy.

Market Expectations

Since the BoE sent hawkish signals at its August meeting, investors have reduced their bets on further interest rate cuts. Markets now see only a one-third chance of another rate cut before the end of the year. If a rate cut is paused in November, this will break the Bank of England's "one rate cut per quarter" rhythm since August 2024.

Economic Growth and Inflation

The British economy has proven to be better than the Bank of England's August forecast, growing by 0.3% in the second quarter, higher than the previous forecast of 0.1%. Nevertheless, the BoE downplayed the positive news, saying that economic fundamentals remain weak and predicting 0.3% growth in the third quarter. Meanwhile, UK inflation is in line with August forecasts, and the BoE expects inflation to climb to a peak of 4% this month - well above inflation rates in the US and the Eurozone. Although this rise in inflation is primarily driven by temporary factors, officials fear that it may lead to "second-round effects" of wages and prices.