UK: A cautious rate cut

The Bank of England cut rates 25bps to 5.00% at today’s Monetary Policy Committee (MPC) meeting.

Consensus expectations were for a cut, but a sizeable number of economists thought they would hold off and in advance of the decision this was widely being described as a "close call". In the event this very much came across as a close call: the vote was 5-4 and even some of those cutting rates described the decision as “finely balanced”.  

Inflation has fallen significantly and you can regard today’s cut as reflecting the significant progress that has been made on reducing inflation. The MPC has become sufficiently confident on the path of inflation to reduce the degree of monetary policy restriction. Note that this 25bps cut still leaves interest rates in restrictive territory and the language around today’s decision didn’t suggest that we should expect a large, swift rate cutting cycle from here.

The committee had been flagging a focus on three areas of data in particular:

1. The state of the labour market (how much slack)
2. Pay growth and
3. Services inflation.

• The minutes note that they judge that the labour market has continued to loosen (but remains tight by historical standards).
• Pay growth has been slowing (but remains elevated).
• Services inflation still isn’t much below 6% year-on-year. That’s too high, in my view, if you want to be confident of sustainably hitting a 2% inflation target. In the minutes they note that services inflation “had remained elevated”. However, looking at the views of those voting to cut today, “the recent strength in services inflation had in part continued to reflect more volatile components of this series.”

In the light of that mix of data, it is perhaps not surprising that the messaging around the rate cut was cautious/hawkish. Governor Bailey talked about them being “highly alert” to inflation persistence. He talked about the key indicators of inflationary pressures remaining elevated. Early on in the press conference, the Governor also said that they need to be careful not to cut rates too quickly (a message that also features in their Monetary Policy Report). He also outlined a scenario, one that he said they put some weight on, where inflation proves more persistent than their "benign" central case.

Looking at their forecasts, which embed a ‘market’ profile for rates where the policy rate falls to 3.5% in three years’ time, the Committee’s mean inflation forecast is at the 2% target two years ahead (and their modal forecast is below this again). At face value, that suggests the MPC could view the market-implied rate path as a reasonable central case… should the economy evolve roughly as expected.

For now, I continue to expect another (data dependent) cut in interest rates later this year (November as a central case) and a gradual and relatively limited rate cut path beyond that. That gradual, cautious approach would fit the messaging above. With the economy not falling into recession and services inflation relatively sticky it makes sense for the Bank to tread carefully.  

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