Citi Expects Bank of England to Pause Rate Cuts This Week — Here's Why

Investing.com - Citigroup expects the Bank of England’s Monetary Policy Committee to keep the bank rate unchanged at 3.75% at this week’s meeting and to remove the rate cut in April from its forecast, as the UK faces another energy shock triggered by Middle East conflicts.

In a report on Friday, Citigroup stated that it now expects the easing cycle to end at 3.25%, with rate cuts anticipated in June and September, higher than previous terminal rate forecasts. This shift reflects increased uncertainty about energy prices and their potential impact on inflation.

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Recent volatility in energy markets has complicated the policy path for the Monetary Policy Committee. According to RAC data, since the conflict began, petrol station prices have risen by 6.7%, equivalent to about 18 basis points increase in the Consumer Price Index.

Due to more volatile fluctuations in jet fuel crack spreads, the impact on airline ticket prices is expected to be more pronounced.

Household energy bills are under significant pressure, with natural gas and electricity futures on Friday showing a 20% increase in the price cap for Q2. However, since the cap is adjusted quarterly, prices will remain fixed throughout the second quarter.

The current situation differs from the 2022 energy shock in several key aspects. The UK economy is at a different stage of the business cycle, with negative output gaps, rising unemployment, and inflation trending downward rather than upward. This shock mainly involves flow issues affecting marginal supply, rather than permanent losses of supply sources.

Citigroup expects the Monetary Policy Committee to remain cautious while keeping policy options open. The bank anticipates either a unanimous vote to hold rates steady or a split vote, with the latter being more likely. A split vote could indicate some members believe this shock may be temporary and that rate cuts could be resumed later if conditions allow.

Since the conflict began, market pricing has changed significantly. Expectations shifted from over 50 basis points of rate cuts to a pricing of 20 basis points of rate hikes by Wednesday. The daily revaluation of the 2026 end-of-year pricing shows an average change of 13 basis points.

The Monetary Policy Committee faces multiple pressures. Politically, the Labour government may introduce fiscal measures to shield households from rising energy prices, possibly including energy bill subsidies or delays in fuel taxes. Such measures could stimulate demand during the cost shock, complicating monetary policy.

Expectations that companies will pass higher energy costs are likely to be more limited than in 2022. Negative output gaps, rising unemployment, and fragile business confidence suggest that firms have limited capacity to pass costs onto consumers without risking nonlinear adjustments in the labor market.

Citigroup believes that, despite current market pricing, the MPC is unlikely to declare the end of an easing cycle.

The bank expects guidance to maintain the possibility of further rate cuts, albeit with conditions to eliminate uncertainties. Minutes from the meeting will provide insights into how each member views the likelihood of ignoring the energy shock.

The long end of the UK bond market has experienced accelerated selling, possibly reflecting renewed concerns over fiscal issues. These include potential costs of energy support measures and calls to accelerate defense spending, which, under current plans, is already facing funding shortages.

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