Another doubtful forecast from Governor Bailey

  • In November last year, Governor Bailey said that markets were wrong to expect Bank Rate to reach 5.2%. Last August, he raised it to 5.25%.
  • Last week he said that it is premature to talk about cutting Bank Rate.
  • Expect, therefore, a cut in Bank Rate, possibly even in Q1 2024.

In November 2022, Andrew Bailey, Governor of the Bank of England, criticised financial markets for expecting Bank Rate (the Bank’s policy rate) to reach 5.2%. In a Comment at the time, I noted that this all but guaranteed at least a 5.2% Bank Rate. On 3rd August this year, the Bank duly raised Bank Rate to 5.25%. 

On 9th November this year, Mr Bailey made another forecast. This time, he said that it was too early to discuss rate cuts and that Bank Rate would remain high for some time, implying of course a long time.

The Governor’s forecasting track record means that markets would do well to consider the possibility of a cut in Bank Rate relatively soon, perhaps even in the first quarter of 2024.

This is of course not just a question of reacting to the Governor’s (and his Bank’s) less than stellar forecasting. There are more valid reasons to expect interest rates to begin to ease relatively soon. Chief among these is the collapse in Britain’s money supply. In the year to September, M4x (that is to say, broad money excluding the deposits of financial institutions), fell by 4.2%, the largest 12-month fall on record. On a monthly basis, M4x fell by 1.1%, the largest fall since December last year and the tenth fall in the last twelve months. 

At the risk of sounding like a broken record, excessively high monetary growth eventually leads to higher inflation – as, for instance, during the Covid pandemic. Similarly, excessively low monetary growth, let alone a sustained contraction in money supply, leads to lower inflation (or possibly even deflation). This is something that central banks nowadays tend to carefully ignore, which is one important reason why they are surprised by inflation development and have to scramble to catch up. 

British broad money growth has been weak (below 5%) since late 2022. It has been below 3% since last March; and negative since September. The message for inflation is clear: although so far sticky, the pace of price rises should decelerate rapidly over coming months. At the same time, economic activity will slow down, again partly because of high interest rates and weak broad money growth. These two factors will combine to raise calls for lower interest rates in the spring. Those calls will be right, and eventually even Governor Bailey will see this. 

What he probably will not see, or not want to acknowledge, is why his and the Bank’s forecasts have been wrong in the past; and what they might consider doing to improve them. 

Gabriel Stein