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Read what our Head of Economics Thomas Broom has to say on the Bank of England’s latest moves. This update highlights the continued rate cuts, the growing focus on inflation and wages, and what it could mean for households, businesses, and markets in the coming months.
In August, the Bank of England’s Monetary Policy Committee reduced bank rate from 4.25% to 4.00%. It was their 5th consecutive quarterly 0.25% reduction since August 2024, in a kind of autopilot markets and forecasters had got quite accustomed to. However, it was accompanied by much more hawkish rhetoric than most expected with members of the committee more vocal about rising inflation and second round effects than they are a slowing economy or higher unemployment.
The spring and early summer was dominated by concerns around global trade and recession risks, whilst in the UK the pace which the labour market was loosening was getting acute focus. The minutes from the MPC’s latest meeting made notably less reference to these dovish factors that may otherwise require lower interest rates. This has been helped especially by recent data revisions to PAYE data that shows employment has not fallen at the pace first feared in the spring.
Instead, their latest minutes had much more focus on headline CPI inflation, services and food inflation components, and wage growth. Our fear is that these factors may see limited reprieve in the coming months, with the Bank of England’s own forecasts suggesting headline and food inflation is set to rise to 4% and 5.5% respectively, and the disinflation in services and wage inflation will be limited. We see some upside risk to these projections.
The MPC also appeared notably concerned about where these current data points are right now than their longer-term forecast, as they are worried that higher inflation now will lead to higher inflation expectations in the future. The central bank targets CPI inflation at 2% and that job gets a lot harder if the average person doesn’t believe that is feasible.
It is widely expected that there will be no change to interest rates in the coming September meeting. Thereafter, the Bank of England face challenging optics to deliver another cut later before year end, given the potential limited progress that may be seen in the inflationary factors that they are currently focusing on.
Bank of England Governor Bailey recently said: “Although we’ve taken a further step, and although I think that the path will continue to be downwards, gradually over time, because policy is still restrictive…. there is now considerably more doubt about exactly when and how quickly we can make those further steps. That’s the message I wanted to get across.”
And financial markets have listened. After the May meeting, investors expected their quarterly reductions to continue in August and November. Now, financial markets place just a 20% probability another cut happens in November. It appears increasingly likely that dovish downside surprises, such as lower inflation or a weaker labour market, may be required in the coming months for another cut to be delivered this year.
Obviously, it is only early September and an awful lot can change between now and year end. Incoming data sheds new light; question marks over the performance of the global economy; potential tax rises in the upcoming Autumn Budget; and ultimately the Bank of England may shift their emphasis towards different factors as the outlook develops.
Importantly, Governor Bailey and external member Mann have both highlighted their willing to reduce interest rates faster should any deterioration in the labour market require. We don’t observe any of the non-linearities usually consistent with a recession. The outlook can potentially, and often does, shift quickly. However right now, the inflationary factors within the MPC’s most recent concerns, may not trend in a favourable direction to allow them to lower rates in the near term.