Money markets are predicting a possible cut in UK interest rates by the Bank of England (BoE) this Thursday, despite persistent inflation in the services sector.
Current odds show a slightly over 58% chance of a 0.25% rate cut, with a 90% likelihood of a cut by September.
Michael Brown, senior research strategist at Pepperstone, described the upcoming decision as one of the hardest to predict in recent years.
With UK interest rates at a 16-year high of 5.25%, this would mark the BoE’s first rate cut in over four years.
A recent Reuters poll reveals that most economists expect the Bank of England’s (BoE) monetary policy committee (MPC) to reduce interest rates at their upcoming August meeting. Conducted between 18 and 24 July, the survey showed that over 80% of the economists—49 out of 60—believe the BoE will implement a rate cut.
In the previous MPC meeting, only two of the nine members voted for a reduction in the Bank rate, while others preferred to see more evidence that persistent inflation is easing before making a change. This cautious stance reflects concerns that inflationary pressures may still be present.
IG analysts commented that while recent softer labour market data supports a 50% chance of a 25 basis point rate cut at the next meeting, the ongoing issue of sticky inflation suggests that interest rates might need to remain elevated for an extended period. Despite this, the argument for a rate cut is gaining strength, making it a potentially close decision.
Meanwhile, Nomura analysts have stated that the Bank of England faces a challenging decision. However, they predict that the BoE will proceed with the first rate cut of this cycle, acknowledging the complexity of the decision given the current economic conditions.
Benjamin Jones, director of macro research at Invesco, stated that the UK’s current inflation situation is more favourable compared to other developed markets. This might encourage the Bank of England to implement a rate cut on 1 August. He warned, however, that if the BoE postpones the cut, it could face difficulties justifying a reduction later in 2024 based on future inflation data.
On the other hand, not all experts agree. Ruth Gregory, deputy chief UK economist at Capital Economics, believes the Bank of England will likely delay any rate cut until its September meeting. She points to the recent economic strength and persistent services inflation as reasons for this cautious approach.
In June, the UK’s inflation rate held steady at 2%, unchanged from May, with rising hotel prices contributing to this stability. Financial markets had anticipated a slight decrease to 1.9%. Services inflation, which includes categories like hospitality, culture, and housing, remained at 5.7% in June, exceeding economists’ expectations.
The main driver of inflation was an increase in prices at restaurants and hotels, with hotel rates rising more than they did a year ago. Conversely, the largest decrease in inflation came from clothing and footwear, where garment prices fell in June after rising in the previous year.
The core inflation rate, excluding energy, food, alcohol, and tobacco, remained steady at 3.5%.
Bank of England Governor Andrew Bailey has previously emphasised the need for policymakers to ensure that inflation remains low.
Sonali Punhani, UK economist at Bank of America Merrill Lynch, commented that the current data does not clearly indicate that inflation is under control. However, she noted that the Bank of England might be prepared to “tolerate and explain away” higher-than-expected price growth and proceed with a rate cut. This approach could be especially relevant if UK inflation rises again later in the year, complicating future communication about rate adjustments.
Kyle Chapman, FX markets analyst at Ballinger Group, highlighted that services inflation remains a significant hurdle for a rate cut, as it is the primary measure the Bank of England (BoE) uses to gauge inflation persistence. Although the headline Consumer Price Index (CPI) has dropped to 2%, this decrease is largely due to temporary factors like falling energy and goods prices, which the bank anticipates will reverse later in the year.
Chapman noted that the BoE needs to be confident that the target inflation rate will be consistently achieved. However, the required reduction in services inflation has not occurred at the pace previously forecasted, with the current rate standing at 5.7%.
This comes in the wake of the European Central Bank (ECB) lowering interest rates to 3.75% in June, marking its first rate cut in five years.
Borrowing costs in the eurozone were reduced from their previous peak of 4%, with the European Central Bank (ECB) joining central banks in Canada, Sweden, and Switzerland in cutting rates. This move comes ahead of the US Federal Reserve.
Eurostat’s latest data showed eurozone inflation decreased slightly to 2.5% in June. However, as with UK inflation, price increases in services remained persistent. The consumer prices index for the eurozone fell from an adjusted 2.6% in May.
The Federal Open Market Committee is expected to keep interest rates steady at a 23-year high of 5.25% to 5.5% following its two-day meeting ending Wednesday. The focus will be on the meeting’s details, which might set the stage for a potential policy shift as early as September.
Brian Sack, head of macro strategy at Balyasny Asset Management, noted, “The Fed is edging closer to a rate cut, and its communication this week should indicate that.”
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