The Bank of England seems to be in a position to drop interest rates on Thursday after maintaining them at a 16-year high of 5.25% for the last year, but markets and experts are sceptical the British central bank would do so.
Economists surveyed by Reuters last week predicted a quarter-point decrease, but believe the vote on the BoE’s Monetary Policy Committee would be tight, with just a 5-4 majority in support.
Late on Wednesday, financial markets were pricing in a 66% likelihood of a quarter-point decrease, with another quarter-point cut likely before the end of the year.
“It will undoubtedly be a tightly balanced conclusion. “You can see it in the market pricing,” said Jack Meaning, Barclays’ top UK economist.
The MPC voted 7-2 in June to keep interest rates on hold, although meeting minutes revealed that some of those who voted to hold were close to voting for a drop.
It’s unclear how those policymakers’ perspectives have changed since then. Only one prospective swing voter, chief economist Huw Pill, commented during the two-and-a-half week period between the conclusion of Britain’s election campaign on July 4 and the start of the BoE’s pre-decision quiet period last week.
There has also been a personnel shift, with former OECD and finance ministry top economist Clare Lombardelli replacing Ben Broadbent as deputy governor, giving the MPC a female majority for the first time.
British consumer price inflation returned to the BoE’s 2% objective in May and remained there in June, down from a 41-year peak of 11.1% in October 2022.
This keeps British inflation lower than in the eurozone, where the European Central Bank reduced rates in June, and the United States, where the Federal Reserve held interest rates unchanged on Wednesday but hinted at a September drop.
However, the BoE expects headline inflation to rise in the coming months and is more concerned about the medium-term sources of inflation: service prices, wages, and broader labour market tightness.
The most significant issue is inflation in service prices. At 5.7% in June, it fell much less than the BoE predicted three months ago.
The dilemma for policymakers is whether this reflects stronger medium-term pressures or one-time impacts such as an increase in accommodation expenses during concert tours by musicians such as American singer Taylor Swift.
NO TIME TO WAIT?
Meaning, a former BoE economist, believes policymakers would be mistaken to postpone a rate drop until September.
“There is always a reason to wait a little bit longer … (but) if you wait until it’s absolutely conclusive, then you’ve probably waited too long,” said the man.
By September, official data is anticipated to show headline inflation back over 2%, making a rate drop seem ill-timed, and, unlike in August, Governor Andrew Bailey has no planned news appearance to explain the decision.
Furthermore, revised BoE estimates on Thursday are expected to show inflation slipping back below its 2% objective in the medium term, necessitating a rate reduction sooner rather than later, given how long it takes for lower interest rates to effect prices.
The September meeting is also when the MPC must have a yearly vote on the rate at which it reverses previous quantitative easing, a decision that it attempts to keep apart from its monthly interest rate votes.
However, it is probable that the MPC may exercise prudence.
In June, Bailey said that policymakers “need to be sure that inflation will stay low” before reducing rates, while Pill stated this month that wages and service prices continued to exhibit “uncomfortable strength”.
So far this year, growth has been better than the BoE and most analysts projected.
“While it will be a very close call, the economy’s recent strength and the stickiness of services inflation leads us to think that the Bank of England will wait,” said Ruth Gregory, Capital Economics’ deputy chief UK economist.
