Bank of England MPC member Megan Greene recently provided a clear signal about the central bank's current thinking on interest rates. In her view, today's economic environment is fundamentally different from the inflationary surge of 2022-2023, suggesting that an automatic return to rate hikes isn't necessary despite new geopolitical shocks.
The immediate trigger for this clarification was the recent turmoil in the Middle East, which briefly pushed Brent crude oil prices to nearly $119 per barrel. This forced the Bank of England to hold its policy rate steady at 3.75% in March, citing the risk of higher inflation. Greene's comments serve to explain why this 'hold' is one of hawkish patience rather than a prelude to more hikes.
Her first key point is that interest rates are much higher in real terms today. In late 2022, when headline inflation peaked at a staggering 11.1%, the Bank Rate was just 3.00%. This meant the real interest rate was deeply negative at around -8.1%. Today, with inflation at 3.0% and the Bank Rate at 3.75%, the real rate is a positive +0.75%. This restrictive stance is already working to cool the economy.
Secondly, Greene highlights that there is 'more slack' in the economy, particularly the labor market. Unemployment has risen to a five-year high of 5.2%, and wage growth is cooling. This is a crucial difference from 2022-23, as it reduces the risk of a dreaded 'wage-price spiral,' where higher wages and higher prices feed off each other.
However, the Bank is not entirely in the clear. The primary concern remains persistent domestic inflation, especially in the services sector, where inflation stood at 4.4% in January. These are the 'second-round effects' the BoE is determined to quell. Therefore, while the bar for further rate hikes is high, the path to rate cuts is also conditional.
The Bank of England is now in a data-dependent, 'wait-and-see' mode. An upcoming cut to the household energy price cap will mechanically lower headline inflation in the short term. The crucial test will be whether services inflation also cools in response to the higher real rates and economic slack. The answer will determine whether the BoE can begin cautiously cutting rates later this year.
- Real Interest Rate: The interest rate adjusted for inflation. It is calculated as the nominal interest rate minus the inflation rate. A positive real rate means policy is restrictive, while a negative one is stimulative.
- Economic Slack: The amount of spare capacity in an economy. In the labor market, it refers to unemployed workers or those who want to work more hours. More slack generally means less pressure on wages and inflation.
- Second-Round Effects: When an initial price shock (e.g., from higher energy costs) leads to a broader, more persistent increase in inflation through channels like higher wage demands and companies raising prices to protect margins.