Ritika Janiya
Interest rates may be cut by the Bank of England this year despite the rise in UK inflation. Traders bet the BoE to cut rates soon, with more cuts probably on their way. But the central bank is cautious, trying to weigh efforts for keeping inflation at bay against boosting economic growth. Some experts were quite confident about more cuts, while others have pointed out that it would be slow for the BoE.
While UK inflation edges up, bets on an imminent interest rate cut from the Bank of England are rife. Indeed, even with the final reading inflation coming in at 2.2% in July, traders believe the BoE is about to lower rates as early as September, then again by the end of the year. The speculation is fuelling mixed optimism among financial markets.
Consumer prices growth came in at 2.2%, a little higher than the previous two months when it was 2%, according to the Office for National Statistics. It had been expected, but it was not as high as some analysts had thought. Perhaps of greater interest to the BoE was that core inflation—which excludes volatile goods like food and energy prices but does reflect services—fell for the sixth consecutive month from 5.7% down to 5.2%. This decline was steeper than was anticipated and has made many believe that the BoE is on course to slice interest rates.
It’s currently pricing in a 45% chance that the BoE will cut interest rates from 5% to 4.75% at its next meeting. That was 36% prior to the inflation report. This shift in sentiment clearly states the impact of the data on the BoE’s policy decisions.
Analysts at Capital Economics point out that, though there was a small rise in inflation, the underlying data is constructive. Ruth Gregory, Deputy Chief UK Economist at Capital Economics, responded with concern over the sharp fall in services inflation. She reiterated that this would embolden the BoE to further slash rates and predicted that interest rates could hit 3% next year. Markets, however, are pricing in a rate of 3.5% in 2025, which is a bit more cautious.
One of the largest surprises of the latest figures was the large falls in inflation for restaurants and hotels—down from 6.2% to 4.9%. Together with the broader-than-anticipated drop in services inflation, that arguably leaves the BoE with greater scope for leeway in interest rates.
That optimism is shared by Pierre Roke at Validus Risk Management, who believes that the most recent inflation data has boosted hopes of two further cuts this year. He pointed out that perhaps now, as the high services inflation in previous times is coming back with these latest figures, this could finally be enough to make the BoE committee feel more comfortable with further cuts.
The BoE normally cuts interest rates when the trend in inflation shows that it is getting close to hitting its target of 2%. Earlier this month, the bank cut the rates to 5% from 5.25%, its first cut after staying steady for a year. However, BoE Governor Andrew Bailey was cautious: it is important to keep inflation low without easing rates too quickly.
A forecast from the BoE added that inflation could climb to 2.75% at the end of 2024 and stay high for a while. The projection indicates that while the BoE may cut rates, this will most likely happen gradually so it doesn’t reignite inflation.
The recent performance of the economy in the UK also has a role in the decisions of the BoE. A second quarter GDP increase of 0.6 percent is seen to have given economists confidence that the BoE will cut the rates. According to Neil Birrell of Premier Miton Investors, the strong set of data puts the BoE in a position where it can proceed with cautiousness, setting the scene for lower interest rates while timing the cuts carefully.
Not everybody, however, is convinced that more cuts are already at hand. According to Suren Thiru of ICAEW, it is precisely this strong second-quarter growth that might delay the next rate cut. Growth, underpinned by factors such as consumer spending for Euro 2024, says Thiru, might just give the BoE enough reason to wait on further cuts.
While such diverging views exist, most of the economists agree that the BoE is likely to wait for some more data before arriving at any decisions. Yael Selfin at KPMG UK commented, “Although inflation picked up a little in July from June, it remained muted by weaker core and food price inflation, which could partly ease the concerns of the BoE’s Monetary Policy Committee and be watching next month’s inflation and labor market reports before deciding further cuts.”.
While the case for rate cuts by the BoE is quite compelling, how many and when remains uncertain. The rate setting committee would hence be very cautious in deciding on future steps, given the fact that inflation is still above target and there is some recovery witnessed in the economy. Investor hopes for immediate cuts may have to be quite patient as the central bank navigates this delicate balance.
