Interest Rates to Fall Sharply

UK currency piled on top of itself
Author: Samuel Beckingham
Updated: Apr 12, 2023
4 minutes read

Silvana Tenreyro, member of the Monetary Policy Committee (MPC), believes that there are sure signs inflation will fall quite significantly below the target of 2%. There will be a plummet in the price of global energy, which will lend itself to shrinking levels of inflation. According to Tenreyro, the Bank of England will need to reduce interest rates much sooner than expected.

In March, the interest rate was raised to 4.25%, but financial analysts are predicting another increase of 0.25% in May and are more than certain there will be another before August. With inflation breaking predictions in February and rising more than expected, not everyone shares Tenreyro’s optimism.

Huw Pill, the Bank of England’s Chief Economist, said it’s not possible to predict if interest rates have risen enough to have combatted inflation sufficiently. Without allowing for the problem to worsen, interest rates need to remain at a high enough level before the Bank Rate can be lowered to maintain a 2% level of inflation. There is, however, always a bit of a lag when it comes to feeling the effects of any rises in the interest rate. It takes time for the markets to adjust and for consumers to settle on deals with mortgages and loans. There is a fine line between getting the levels right and not putting up costs too high.

The MPC holds the strong belief that supply chain issues arising from the pandemic, as well as soaring energy costs, are starting to decrease. This all points to a sharp decline in inflation. Tenreyro observes that the steep drop in oil prices has come much faster than anyone could have predicted. They are currently much lower than they were immediately following Russia’s invasion into Ukraine last year. Supply and costs are on par with pre-pandemic levels.

While previous interest rate hikes are predicted to see an effect over the course of 2023 and into next year, demand will lessen and drag down levels of inflation. In Tenreyro’s opinion, because of this, inflation is most likely going to fall below the 2% target. That is, as long as no further unexpected market events occur between now and the end of next year.

Other analysts aren’t so certain, as the global banking system has been volatile recently. We could see more increases in borrowing costs as a result, which would work counterproductively against Bank Rate increases we’ve already had. While the stability of banks have been called into question, price rises associated with regular business could be pushed onto the consumer.

On the issue of banks, Tenreyro believes the MPC will act in the best way possible if their funding starts to have a negative effect on inflation. Any increase in the Bank Rate will need to be considerate of credit conditions. In effect, while interest rates will eventually return to a more historic level below 0.6%, it may be a while before this happens. Despite the Bank of England realising that inflation could fall rapidly, the MPC will only adjust the Bank Rate when the time is right.