The markets were all but certain that the Bank of England (BoE) would cut interest rates in August, with the Bank previously hinting at that. However, hopes of a summer interest rate cut have been knocked by a member of the BoE’s rate-setting committee.
Interest rates have been kept at a 16-year high of 5.25% in an attempt to slow consumer prices rising, but higher rates have pushed up the cost of borrowing, including for mortgages.
With inflation finally hitting its 2% target in May, markets were almost certain of a summer rate cut.
Pouring cold water on City predictions, the BoE’s Jonathan Haskel said inflation was on course to return above the BoE’s 2% target.
“I would rather hold rates until there is more certainty that underlying inflationary pressures have subsided sustainably,” said Haskel, a member of the Bank’s monetary policy committee (MPC), in a speech at King’s College London on Monday.
Haskel is an external member of the MPC, with his term due to end on 31 August. While some members of the Bank’s nine-strong MPC have pushed for a cut in official borrowing costs over recent months, Haskel has voted to keep rates on hold.
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“The playing out of those shocks through the economy, and the continued tight and impaired labour market, means that inflation will remain above target for quite some time,” Haskel said.
Bank governor Andrew Bailey has previously emphasised inflation must be sustainably close to target before the Bank acts.
Basic wage growth remains at 6% — almost double the rate most policymakers view as 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 rate of inflation.
Experts have cautioned that a rate cut this summer could be less likely until the majority of the MPC feel certain that inflation is under control.
“The Bank will be keen to avoid a policy error in which it cuts rates but then has to hold fire or, worse, outright reverse the easing due to forces beyond its control,” Julian Howard, chief multi-asset investment strategist at GAM said.
Globally, inflation is showing signs of returning, with the Federal Reserve delaying its rate-cutting pathway and the European Central Bank increasing its inflation forecasts for the rest of the year.
The BoE forecasts inflation to be at 2.5% by the end of 2024, with price rises only returning to 2% sustainably in early 2026.
Another variable coming to the table at Threadneedle Street is the new UK government’s pledge to make the minimum wage a “genuine living wage”. That follows a nearly 10% increase in April for the lower wage threshold.
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The party has said it will implement its “new deal for working people” 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 magnitude of the change remains uncertain,” said James Moberly and Sven Jari Stehn, economists at Goldman Sachs.
The UK’s central bank warned in June that the national living wage hike in April “could have a bigger impact than expected”.
Before the August meeting, the Bank’s MPC will have another set of inflation data, due 17 July, and wage data, 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 1 August. It would be the first cut since the start of the pandemic and bring relief to homeowners who have been squeezed by higher mortgage costs since the start of the year.
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Some are even more certain, with a money markets trader placing a £2m bet on the BoE making the biggest interest rate cut in four years next month.
The trader would stand to net an £8m profit should policymakers reduce borrowing costs by half a percentage point from 5.25% to 4.75% in August, according to Bloomberg.
The last time the BoE cut interest rates by half a percentage point was in the days after Britain was plunged into the first Covid lockdown in March 2020, when it reduced borrowing costs from 0.75% to 0.25%.
The Bank of England will announce its interest rate decision on 1 August around noon, which will be accompanied by a quarterly monetary policy report where new forecasts will be unveiled. There will also be a press conference, where Bailey will speak for the first time since the general elections.
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