Sunday, December 22, 2024

Possibility of multiple Bank of England interest rate cuts rises on jobs and inflation data

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Traders have raised bets that the Bank of England (BoE) will cut interest rates in September despite a rise in UK inflation as the closely watched services inflation reading actually fell by more than expected.

The consumer prices index (CPI) rose for the first time this year to 2.2% in July, up from 2% in both May and June, according to the Office for National Statistics (ONS). This was less than the 2.3% rise expected by analysts.

Services CPI inflation dropped for a sixth consecutive month from 5.7% to 5.2%, having been forecast by analysts to fall to 5.5%.

Money markets now indicate that there’s a 45% chance that Bank will cut rates to 4.75% next month, from its current level of 5%. Before the inflation data came out, a September rate cut was only a 36% probability, according to City pricing.

Markets still think there are two cuts to come this year, which would bring the base rate down to 4.5%.

Capital Economics analysts say inflation rose by less than expected, and that the data behind headline inflation is encouraging.

“The sharp fall in services inflation from 5.7% to a two-year low of 5.2% will reassure the Bank of England that the disinflation process is on track and opens the door to more interest rate cuts later this year,” Ruth Gregory, deputy chief UK economist at Capital Economics, said.

Capital believes interest rates will fall throughout next year to 3%. Markets currently think 3.5% is a more likely destination in 2025.

“The main surprise was that the fall in restaurants and hotels inflation from 6.2% to 4.9% was bigger than the drop to 5.6% we had forecast.

“And importantly for the Bank of England, the decline in services inflation from 5.7% to 5.2% was much bigger than anyone anticipated,” Gregory added.

Read more: UK inflation rises to 2.2% in first increase this year

Pierre Roke, associate at Validus Risk Management also believes two more interest rate cuts are possible this year.

“Today, markets had a keen interest in services inflation — after two consecutive months of hotter-than-expected readings at 5.7%, the hawkish Bank of England committee members, who voted to hold, highlighted this as a critical factor, making it a key market signal. Today’s 5.2% print vs 5.5% expected print validates the more dovish committee members and potentially leaving room for not just one more cut this year but two,” he said.

The Bank of England tends to cut interest rates as inflation comes down towards its 2% target. It cut rates from 5.25% to 5% earlier this month after holding them at this level for a year.

Governor Andrew Bailey struck a cautious tone after announcing the first cut in interest rates.

“We need to make sure inflation stays low and be careful not to cut interest rates too quickly or by too much,” Bailey said.

According to a Bank of England forecast released earlier this month, inflation will rise to 2.75% by the end of 2024 and stay high for the foreseeable future.

Neil Birrell, chief investment officer at Premier Miton Investors, said: “The good news is that it came in below expectations, driven by a bigger than expected fall in services inflation in July.

“That gives hope that the Bank of England can continue to ease policy even in the face of other strong data in the jobs market.”

Read more: FTSE 100 LIVE: European stocks climb as traders raise bets on September rate cut after UK inflation data

The Bank of England has made clear that it wants to see services inflation fall before it will feel confident cutting interest rates further.

Yael Selfin, chief economist at KPMG UK, said: “Despite a modest rise, inflation was relatively subdued in July as weaker core and food price inflation largely offset the diminishing impact of earlier falls in energy prices.

“This should provide a degree of comfort for MPC members as the Bank’s own forecasts earlier this month pointed to a sharper uptick.”

Deutsche Bank also believes that it possible the UK will see multiple interest rate cuts before the end of the year.

“We will get another CPI report ahead of the September decision. The next round of inflation and labour market data will be crucial in deciding whether the MPC could push through a September rate cut.

The latest jobs data also showed a cooling down in wage increases, which should appease Threadneedle Street.

Average earnings excluding bonuses slowed to 5.4% from 5.8% in the three months to June and was 2.4% higher after taking inflation into account, said the Office for National Statistics. It is the lowest rate in almost two years in the three months to June.

Read more: Where to invest your money when interest rates are falling

Ed Monk, associate director for personal investing at Fidelity International, said: “Easing wage rises reported yesterday point to a similar trend and suggest we remain on track for further cuts to interest rates in the months ahead.”

“While not our base case, the odds of a back-to-back rate cut are on the rise. A September rate cut should no longer be off the table. And it’s entirely conceivable to think that we could get multiple more rate cuts this year.”

However, some analysts are not so bullish on the Bank of England cutting rates, as inflation is now back off target.

Monica George Michail, associate economist at the NIESR, said: “Underlying inflationary dynamics continued to slow with core inflation at 3.3% and services inflation at 5.2%. Despite the lower figures, these remain elevated and may lead the Bank of England to exercise some caution with regards to further interest rate cuts.”

Catherine Mann, a hawkish member of the Monetary Policy Committee, which sets interest rates, said this week that the UK should not be “seduced” into thinking inflation will stay low over the coming year.

Aaron Hussein, global market strategist at JP Morgan Asset Management, also suggests the Bank is unlikely to cut in September:

“Today’s inflation print will reassure members of the committee that voted for a rate cut last month that they may finally be taming the inflation beast

“However, with economic growth on a cyclical upswing since the start of the and the labour market remaining resilient, there remains a risk that cutting too quickly will fan the inflation flames. We therefore think it’s unlikely that the Bank will follow up its August cut with a cut in September. Absent any material shock to growth, this cutting cycle is likely to be gradual with a quarterly cadence most likely.

“Investors banking on imminent rate cuts will therefore be disappointed.”

The UK’s CPI inflation rate was below France’s (2.6%) and Germany’s (2.6%) in the 12 months to July this year. It’s also slightly lower than the latest figure from the Eurozone, which also stands at 2.6%.

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