Friday, October 11, 2024

Traders ramp up bets on Bank of England interest rate cut amid GDP growth

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Traders are increasingly convinced that the Bank of England (BoE) will slash interest rates next month, with money markets indicating a 93% probability of a cut from 5% to 4.75% in November.

The bullish sentiment follows the latest data from the Office for National Statistics (ONS), which revealed that the UK economy grew by 0.2% in August, marking a modest recovery after two months of stagnation in June and July.

Economic advisor Joe Nellis from MHA said: “While the moderate growth in GDP will be welcomed by the government and businesses, it highlights a UK economy that has been close to stagnation since July. The overly cautious and sometimes negative messaging from the government, coupled with uncertainty surrounding the forthcoming budget, has undoubtedly dampened corporate investment and household spending.”

Read more: FTSE 100 LIVE: Stocks open lower as construction pushes UK economy out of stagnation

He added: “The government will be hoping that their long-overdue budget and a possible cut in interest rates by the Bank of England early next month will create a more conducive environment for investment, reigniting growth in the UK economy.”

The services sector was the primary driver of growth, increasing by 0.1% in August, while the production sector rebounded with a 0.5% increase after a prior contraction. Construction output also showed resilience, growing by 0.4% in August.

Ashley Webb, UK economist at Capital Economics, stated that the ONS data supports the notion of a mild slowdown rather than a recession. The consultancy predicts a 0.1% increase in GDP for September and estimates growth of 0.2% to 0.3% for the third quarter overall. Webb affirmed expectations for a gradual reduction in interest rates, predicting a cut to 4.75% in November, followed by potential further reductions at subsequent meetings.

Ellie Henderson, economist at Investec, also expects the BoE to continue easing borrowing costs.

“Providing the 30 October budget does not include any major curveballs, there are reasons to be optimistic moving forward, too.

“The household balance sheet is looking healthy; not only are nominal income gains outstripping inflation, implying real household income growth, the saving ratio is still elevated, at 10% in the last reading, giving room for spending growth to exceed real income growth if households so choose.

“Meanwhile on the business side, investment should be supported by lower interest rates, as the Bank of England looks to continue its easing cycle.”

With inflation projected to remain around the BoE’s target of 2%, the upcoming consumer price index (CPI) report due on 16 October will be key for the BoE’s decision. CPI inflation held steady at 2.2% in August, suggesting the possibility of a rate cut if inflation remains contained. The market is currently pricing in two quarter-point reductions by the end of the year.

Read more: UK economy returns to growth in August

Susannah Streeter, head of money and markets at Hargreaves Lansdown, noted that stable inflation in August raised hopes for continued calm in September prices. However, the uncertainty surrounding the upcoming budget may make consumers more cautious. She highlighted concerns over persistent wage growth, which could contribute to inflation if not managed carefully.

BoE governor Andrew Bailey hinted at a more aggressive approach to cutting borrowing costs, stoking speculation about easing inflationary pressures.

Yet, caution remains among policymakers, particularly regarding potential inflation rebounds. Recent shifts in market expectations suggest an 82% chance of a rate cut in November, though some traders have tempered predictions for consecutive cuts later in the year.

Sarah Coles, personal finance columnist at Yahoo Finance UK and head of personal finance at Hargreaves Lansdown, described the current inflationary landscape as a “push-me-pull-you” situation. She said that while grocery inflation might rise due to poor harvests, broader shop prices, including petrol, are falling.

“It’s a push-me-pull-you month for inflation, which is likely to keep the Bank of England on track for a rate cut in November. Grocery inflation is likely to have risen in September, thanks to poor harvests hiking prices of items like chocolate and olive oil. However, shop prices more broadly may have fallen, and petrol prices have also been dropping, which could leave inflation around the Bank of England’s target.”

She added: “This may be the last of the good news on inflation for a while, because October’s figures could look more grizzly.”

However, the return of the UK economy to growth means a cut in interest rates as soon as November isn’t certain, argued Suren Thiru, ICAEW economics director.

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Thiru said: “The UK economy could blow a bit hot and cold over the near term, as the lift to incomes from muted inflation is hindered by growing consumer and business caution amid global geopolitical uncertainty and probable tax hikes.

“While interest rates are still likely to fall in November, these positive figures mean it’s not quite a done deal, as they give the more hawkish rate setters enough encouragement regarding economic conditions to hold off voting to relax policy.”

Nicholas Hyett, investment manager at Wealth Club, also believes the latest GDP figures creates problems for the BoE.

He said: “This is all welcome news for the Treasury ahead of the budget which is expected to see taxes rises, potentially slowing economic activity. It does raise a conundrum for the Bank of England though.

“The Bank had been eyeing up further interest rate cuts, but the economy doesn’t look like it’s crying out for more monetary support and with inflation expected to accelerate again into Christmas, rate setters might be thinking it makes sense to sit on their hands a little while longer.”

The Bank of England’s Monetary Policy Committee (MPC) will meet on 7 November to announce their decision on the base rate.

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