By William Schomberg, David Milliken and Suban Abdulla
LONDON (Reuters) -The Bank of England paved the way on Thursday for the start of interest rate cuts as soon as next month and Governor Andrew Bailey said there could be more reductions than investors expect.
The BoE's Monetary Policy Committee kept rates at a 16-year high of 5.25% but Deputy Governor Dave Ramsden joined external MPC member Swati Dhingra in backing a cut to 5%, the central bank said.
Economists polled by Reuters had mostly expected an 8-1 split to keep rates on hold.
British government bond yields fell and sterling briefly dipped against the dollar.
After cutting rates in March 2020 as the coronavirus pandemic swept the world, the BoE began raising borrowing costs in December 2021 - earlier than other leading central banks - to counter high inflation which peaked at 11.1% in October 2022.
Headline inflation has since fallen back and the BoE expects it slowed to around its 2% target in April, largely because of falling energy prices.
The central bank remains on guard because of still-strong growth in wages and services prices which it expects to temporarily push inflation above 2% later this year.
But Bailey sounded hopeful that higher borrowing costs were doing their job.
"We need to see more evidence that inflation will stay low before we can cut interest rates," he said. "I'm optimistic that things are moving in the right direction."
Bailey added the BoE might need to cut rates by more than the market expected and it could start at its next scheduled MPC announcement on June 20.
"Let me be clear, a change in Bank Rate in June is neither ruled out nor a fait accompli," Bailey said.
Investors have been trying to work out whether the BoE is likely to cut rates in June - when the European Central Bank has already signalled it will move - or, like the U.S. Federal Reserve, will hold out longer.
On Wednesday, Sweden's central bank cut its key interest rate for the first time in eight years.
A cut by the BoE could offer a lifeline to Prime Minister Rishi Sunak who has told voters that the economy is turning a corner but is struggling to reduce the opposition Labour Party's big opinion poll lead before an election later this year.
Finance minister Jeremy Hunt sought to dispel any sense that the government wanted to pressure the BoE.
"I would much rather that they waited until they're absolutely sure inflation is on a downward trajectory than rushed into a decision that they had to reverse at a later stage," he told reporters after the BoE's announcement.
FOCUS ON THE DATA
In an attempt to spell out its likely next steps, the BoE said it would consider how the upcoming economic data "inform the assessment that the risks for inflation persistence are receding."
Two official sets of labour market and two rounds of inflation figures are due before June 20.
"We think some soft inflation and wages data may be enough to prompt it to cut rates at the next meeting in June, if not at the following meeting in August," Paul Dales, chief UK economist at consultancy Capital Economics, said.
But Hetal Mehta, head of economic research at investment managers St. James's Place, said: "Any expectations of a rate cut in June would be premature as base effects will only temporarily get inflation down to target."
The pound fell by about a third of a cent against the U.S. dollar after the BoE's announcements before rising later.
The yield on two-year British government bonds, which are most sensitive to BoE rate speculation, fell by 4 basis points.
Financial markets priced in a first quarter-point BoE rate cut by August and saw another before the end of the year, little changed on the day.
The BoE sent another message to investors that their bets on rate cuts might be too conservative as it cut its inflation forecasts for two and three years' time to 1.9% and 1.6% - below its 2% target - from its February projections of 2.3% and 1.9%.
The BoE's inflation forecasts partly reflect market interest rate expectations in the run-up to its MPC meetings.
"It's likely that we will need to cut bank rates over the coming quarters and make monetary policy somewhat less restrictive over the forecast period, possibly more so than currently priced into market rates," Bailey said.
There were differences between the seven MPC members who voted to keep rates on hold around how persistent inflation pressures would be, and how much more evidence of a slowdown was needed to justify a rate cut, minutes of their meeting showed.
Wage growth and services price inflation of around 6% remain higher than in the United States or euro zone, even though British economic growth is more sluggish.
But Ramsden and Dhingra said a cut was needed now because of the time lag in monetary policy decisions impacting the economy and because inflation might fall more than the BoE had forecast.
The BoE slightly lifted its growth forecasts for Britain's economy, saying it expected 0.5% growth in gross domestic product over 2024, up from 0.25% in its February forecast.
It said a recession in the second half of 2023 had probably ended, offering some relief to Sunak and his struggling Conservative Party.
(Additional reporting by Andy Bruce, Writing by William Schomberg, Graphics by Sumanta Sen, Editing by Jane Merriman)
