Market Analysis

The Bank of England's potential interest rate cut next week, its first since 2020, remains uncertain, with heightened ambiguity as key policymakers have remained silent for over two months due to pre-election regulations leading up to the July 4 election.

Investors are speculating whether the recent higher-than-expected services prices will deter the central bank from lowering rates from their 16-year peak of 5.25%.

Interest rate futures currently indicate a 50% probability of a quarter-point rate reduction on August 1. While most economists surveyed by Reuters still anticipate a cut, many would not be surprised if the BoE decided to wait until its subsequent meeting on September 19.

RBC Capital Markets' global macro strategist Peter Schaffrik and senior UK economist Cathal Kennedy expressed the closeness of the decision in a note to clients on Thursday, saying, "We've run out of ways to describe how close the decision next week will be."

In the previous month, the BoE's Monetary Policy Committee voted 7-2 to maintain rates, but the meeting minutes revealed that the decision was "finely balanced" for some policymakers who opted against a cut.

Governor Andrew Bailey, in a written statement accompanying June's decision, emphasized that policymakers "need to be sure that inflation will stay low" before cutting rates.

Financial markets are anticipating only gradual easing, with two quarter-point cuts projected for this year and an additional three or four cuts in 2025, potentially reducing rates to around 4%.

Consumer price inflation hit the BoE's 2% target in May and June, down from 6.7% in August 2023 when the BoE last raised rates. This is lower than inflation in the United States or the euro zone, where the European Central Bank cut rates in June.

In the short term, this may represent the peak for the BoE. Both the central bank and most external economists predict inflation will rise in the coming months as the significant drop in energy prices from last year no longer affects the annual price index.

Underlying Price Pressures

The BoE has stated that its rate cut decision will focus on underlying inflation pressures, including wage growth, labor market tightness, and services prices.

Since June's rate decision, the job market has shown signs of easing, with fewer vacancies and a slight increase in unemployment.

Wage growth has also decelerated, although at 5.7% in the three months to May, it remains roughly double the rate deemed compatible with 2% inflation by the BoE, and is expected to slightly exceed the BoE's projection for the second quarter.

However, the significant anomaly is service price inflation, which was 5.7% in June, surpassing the BoE's 5.1% forecast.

This deviation was largely due to unusually high hotel prices, possibly linked to concert tours that month. It remains uncertain to what extent MPC members will discount this reading.

Among the four who have spoken publicly since the BoE lifted its election campaign restrictions, only Chief Economist Huw Pill is considered a swing voter. Pill described the possibility of an August rate cut as "an open question." He noted "uncomfortable strength" in wage inflation and services prices but also suggested that inflation pressures might be starting to ease.

Particular uncertainty surrounds the views of deputy governors Clare Lombardelli and Sarah Breeden. Lombardelli recently joined the BoE after a long career at the finance ministry, and Breeden's last substantial comments on monetary policy were in February.

Stronger-than-expected economic growth in the first five months of 2024 might lessen the urgency for the MPC to cut rates.

RBC predicts the BoE will revise its 2024 growth forecast to 1% from May's 0.4% prediction, following a modest 0.1% expansion in 2023 as Britain dealt with rising energy costs post-Russia's full-scale invasion of Ukraine.

However, James Smith, developed markets economist at ING, cautioned against seeking too much certainty that inflation pressures have subsided. "Decent growth for the rest of 2024 relies, in part, on those cuts being delivered, a fact that won't have been lost on BoE officials," he said.

Paraphrasing text from "Reuters" all rights reserved by the original author.