Markets were almost certain that the Bank of England (BoE) would cut interest rates in August, which the Bank had previously indicated. But hopes of a summer rate cut were dashed by a member of the BoE’s rate-setting committee.
Interest rates were held at a 16-year high of 5.25% in an effort to slow rising consumer prices, but the higher rates raised the cost of borrowing, including mortgages.
With inflation finally hitting its 2% target in May, markets were all but certain of a summer rate cut.
The BoE’s Jonathan Haskel poured cold water on the City’s forecast, saying inflation was on track to return above the BoE’s 2% target.
“I would prefer to keep rates on hold until there is more certainty that underlying inflationary pressures will sustainably subside,” Haskel, a member of the Bank’s Monetary Policy Committee (MPC), said in a speech at King’s College London on Monday.
Haskel is an external member of the MPC whose term is set to end on 31 August. While some members of the bank’s nine-member MPC have pushed for a cut in official borrowing costs in recent months, Haskel voted to keep rates on hold.
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“The play-through of these shocks through the economy and the continued tight and disrupted labor market means that inflation will remain above target for some time to come,” Haskel said.
Bank Governor Andrew Bailey has previously stressed that inflation must be sustainably close to target before the Bank intervenes.
Core wage growth remains at 6% – almost double the rate most policymakers consider consistent with 2% inflation. Services inflation is also stubbornly high at 5.7% in May and core inflation which was 3.5%. Core CPI is a concern because it is falling more slowly than the headline inflation rate.
Experts have warned that a rate cut this summer could be less likely until the majority of the MPC is confident that inflation is under control.
“The Bank will want to avoid a policy mistake where it cuts rates but then has to hold fire or, worse, reverse the easing outright due to forces beyond its control,” said Julian Howard, chief multi-asset investment strategist at GAM . .
Globally, inflation is showing signs of rebounding, with the Federal Reserve delaying its rate-cutting path and the European Central Bank raising its inflation forecasts for the rest of the year.
The BoE forecasts inflation at 2.5% by the end of 2024, with price growth returning sustainably to 2% in early 2026.
Another variable coming to the table in Threadneedle Street is the new UK government’s commitment to make the minimum wage a “genuine living wage”. This follows a nearly 10% increase in April at the minimum wage.
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The party said it would implement its “new deal for workers” in full within the first 100 days.
“Labour’s pledge to introduce a ‘real living wage’ points to the possibility of stronger wage growth and some risk of slower rate cuts, but the extent of change remains uncertain,” said James Moberly and Sven Jari Stehn, economists at Goldman Sachs.
The Bank of England warned in June that the national living wage increase in April “may have a bigger impact than expected”.
Ahead of the August meeting, the Bank’s MPC will have another set of inflation data, due on July 17, and wages data to be released the following day. The MPC will also have a new member, Clare Lombardelli, to replace Ben Broadbent, who voted to keep rates unchanged in June.
Despite the headwinds, investors currently estimate there is a 60% chance the BoE will cut interest rates to 5% at its next meeting on August 1. It would be the first cut since the start of the pandemic and would bring relief to homeowners who have been pushed by higher mortgage costs since the beginning of the year.
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Some are even more confident with money market traders betting the BoE will make the biggest rate cut in four years next month.
According to Bloomberg, the retailer would make a net profit of £8m if policymakers cut borrowing costs by half a percentage point from 5.25% to 4.75% in August.
The last time the BoE cut interest rates by half a percentage point was in the days after Britain plunged into the first Covid lockdown in March 2020, when it cut borrowing costs from 0.75% to 0.25%.
The Bank of England will announce its interest rate decision around midday on August 1, accompanied by its quarterly monetary policy report, where new forecasts will be revealed. There will also be a press conference where Bailey will speak for the first time since the general election.
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