Market Analysis

Bank of England Nears Rate Cut from 16-Year Peak

Amos Simanungkalit · 01 Aug 202418.6K Views

The Bank of England appears poised to cut interest rates on Thursday, following a year of holding them at a 16-year high of 5.25%. However, uncertainty persists among markets and economists about whether the central bank will actually proceed.

A recent Reuters poll revealed that most economists anticipate a quarter-point cut, though they expect a narrow 5-4 majority vote on the BoE's Monetary Policy Committee. By late Wednesday, financial markets were predicting a 66% likelihood of a quarter-point reduction, with expectations for an additional cut before year's end.

"It's certainly going to be a finely balanced decision. You can see that from the market pricing," stated Jack Meaning, Barclays' chief UK economist.

In June, the MPC voted 7-2 to maintain the current rate, though meeting minutes indicated that several members were close to voting for a cut.

Shifts in policymakers' views since then remain unclear. Only one potential swing voter, chief economist Huw Pill, has spoken publicly during the period between the end of the UK's election campaign on July 4 and the start of the BoE's pre-decision quiet period last week. Additionally, Clare Lombardelli has replaced Ben Broadbent as deputy governor, resulting in a female majority on the MPC for the first time.

British consumer price inflation hit the BoE's 2% target in May and remained steady in June, down from October 2022's 41-year high of 11.1%. This places UK inflation lower than that of the eurozone and the US, where the European Central Bank and Federal Reserve have recently adjusted rates.

However, the BoE anticipates a slight rise in headline inflation in the coming months and is more concerned with medium-term inflation drivers such as services prices, wages, and labor market tightness. Services price inflation, at 5.7% in June, has not decreased as much as the BoE forecasted three months ago.

Policymakers must determine if this reflects greater medium-term pressures or is due to one-off events like increased hotel prices during concerts by artists such as Taylor Swift.

Jack Meaning, a former BoE economist, argues that delaying a rate cut until September would be a mistake. "There is always a reason to wait a little bit longer ... (but) if you wait until it's absolutely conclusive, then you've probably waited too long," he said. By September, headline inflation may rise above 2%, making a rate cut appear ill-timed. Additionally, there is no scheduled press conference in September for Governor Andrew Bailey to explain the decision.

Updated BoE forecasts on Thursday are likely to show medium-term inflation falling below the 2% target, suggesting that a rate cut is necessary sooner rather than later, considering the time it takes for lower rates to impact prices.

September's meeting also includes the annual vote on the pace of reversing past quantitative easing, which the MPC tries to separate from regular interest rate decisions.

Nonetheless, the MPC might choose caution. Bailey stated in June that policymakers need assurance that inflation will remain low before cutting rates, and Pill mentioned last month that wages and services prices still exhibited "uncomfortable strength." Furthermore, economic growth this year has surpassed expectations.

"While it will be a very close call, the economy's recent strength and the stickiness of services inflation leads us to think that the Bank of England will wait," said Ruth Gregory, deputy chief UK economist at Capital Economics.