What factors influence the Bank of England MPC when setting Base Rate?

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Matt Foley joins Avamore Capital as Director of Credit

2024 started strong with expectations of multiple cuts to the UK Base Rate – it was certainly a case of when rather than if, with some forecasters predicting 2024 would end with Base Rate below 4%.

High street banks announced cuts to mortgage rates in early January and there was a feeling of optimism that 2024 would start well and continue to improve as the year progressed.

As we enter the 5th month of the year, Base Rate remains at 5.25% with mortgage rates increasing, reversing some of the cuts seen at the start of the year.

General market consensus is that the first cut will be in July or August with a lot of people (including me!) scouring the Monetary Policy Committee (MPC) meeting minutes to search for any hint to support a forecast.

So, what factors does the MPC look at when considering a Base Rate cut?

  1. Monetary Policy Objectives: The objectives set by the Bank of England, such as price stability, economic growth, and financial stability, guide interest rate decisions. The MPC considers these objectives and assesses the trade-offs involved in adjusting interest rates. Over the last 12-18 months, inflation has been the key driver which saw Base Rate rise from historic lows of 0.1% (Mar 20- Dec 21) to its current rate of 5.25%. Inflation peaked at over 11% in October 2022 with data from March 2024 showing that it has now fallen to 3.2%, still above the target of 2%.

 

  1. Economic Growth: The rate of economic growth is a critical factor in determining interest rates. The rapid rise in Base Rate led to weak economic growth with the UK entering a recession at the end of 2023 following 2 consecutive quarters GDP contraction. Whilst this weak growth would ordinarily lead to a reduction in Base Rate to encourage spending, inflation was too high, and a stagnant economy was an acceptable consequence of controlling inflation.

 

  1. Inflation: Inflation, the rate at which prices for goods and services rise, is a crucial factor in interest rate decisions. This has certainly been at the forefront of the public’s thoughts with the peak in October 2022 being the highest level ever seen in the UK.

 

  1. Unemployment Rates: The level of unemployment in the economy is closely monitored when forecasting interest rates. Low unemployment rates suggest a strong labour market and increased spending power, which may lead to higher interest rates. Conversely, high unemployment rates may prompt policymakers to lower interest rates to stimulate job creation and boost economic activity. The difficult market conditions (high inflation, high Base Rate and a stagnant economy) appear to have had little impact on the UK’s unemployment rate. It currently stands at 4.2% (ONS – Dec 23 to Feb 24) and the rate hasn’t been above 5% since Jan – Mar 2021. The strong labour market results in wage inflation fuelling inflation in the wider economy.

 

  1. Global Economic Factors: The global economic environment also plays a role in the UK base rate interest forecast. Factors such as global growth rates, geopolitical events, and trade dynamics can have spillover effects on the UK economy. Changes in global interest rates and financial conditions can influence the decisions made by the Bank of England regarding the base rate. There has certainly been a myriad of external events that have significantly impacted the UK – Ukraine War, Conflict in the Middle East, Disruption to Shipping to name a few.

 

  1. Financial Market Conditions: The state of financial markets, including stock markets, bond markets, and currency markets, is closely monitored. Market volatility, credit conditions, and investor sentiment can impact the base rate forecast. Central banks consider the stability and functioning of financial markets when determining interest rates.

As you can see, there are multiple conflicting factors that make Base Rate setting a very complex task, and even harder to predict.

The interplay between these factors and the dynamic nature of the economy makes interest rate setting and forecasting constantly subject to change based on new data and evolving circumstances.

At Avamore, and as Director of Credit, it is important that we stay abreast of all these factors and make careful, considered lending decisions that do not put our clients under undue stress or risk.

We have supported our clients through the good times and the difficult times being solutions focused when needed.

This is part of our DNA, our culture, and will continue to be so as we push to achieve our ambitious growth targets.

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