Monetary Policy Issues in the UK: United Kingdom

After hiking rates 14 consecutive times between December 2021 and August 2023 to arrest above-target inflation, the Bank of England (BoE) has held rates at 5.25 percent since then. As the BoE prepares for easing, this paper examines three concurrent monetary policy questions: (a) how have the macroeconomic and financial effects of BoE monetary tightening during the current cycle compared with experiences in other major advanced economies (AEs), and with previous UK tightening cycles; (b) what is the impact of US Fed decisions on UK monetary transmission, and the attendant implications thereof for BoE communications; and (c) how do model-based predictions of UK monetary policy paths (which seek to stabilize inflation and the output gap) compare with staff’s recommended path in the 2024 Article IV consultation. We find that (a) monetary transmission has largely mirrored previous episodes (and experiences in other major AEs), with the most notable exception of the mortgage channel, which has been slower due to a higher share of fixed-rate mortgages; (b) an outsized impact of Fed announcements on UK financial markets places a premium on BoE communications in a context where the BoE may diverge from the Fed; and (c) optimal rate path predictions are close to staff’s recommended path, although if the BoE attached a high weight to concerns about a prolonged period of above-target inflation leading to de-anchoring of inflation expectations, a slower pace of cuts would be warranted.