Fading optimism for interest rate reduction due to persistently high wage increases
In a recent turn of events, the Bank of England's decision to cut interest rates remains uncertain, despite dismal employment figures and high wage growth. This uncertainty stems from the Monetary Policy Committee's (MPC) concerns about persistent inflationary pressures and the risk that inflation expectations could affect price-setting.
According to Andrew Wishart at Berenberg, pay growth remains above the 3% year-on-year rate, which is usually consistent with 2% consumer price inflation. The Bank of England expects inflation to reach 4% later this year, double its 2% target, primarily due to higher food prices. This mixed economic picture has led to a split MPC vote, with some members favouring a cautious and gradual approach rather than an immediate rate cut.
Key concerns regarding inflation include the risk of inflation expectations becoming entrenched, which could keep inflation persistently above the target. The MPC also wants to ensure inflation stays low and stable over the medium term before cutting rates further. Global uncertainties, including trade policy changes, add complexity to the inflation outlook and monetary policy decisions.
Andrew Wishart at Berenberg expects the Bank to hold off from another interest rate cut until 2026. James Smith, UK economist at ING Bank, suggests that while the Bank can still afford to cut rates in November, the call has become less clear-cut. This cautious approach was reflected in the recent 5–4 MPC vote to reduce the Bank Rate by only 0.25 percentage points to 4%, rather than maintaining it.
Unemployment in the three months to June remained at 4.7%, the highest unemployment rate since 2021. However, the Bank's meeting highlighted increasing concerns about inflation rather than unemployment. The number of employees on UK payrolls has declined for six months in a row, with a decline of 8,000 in July.
Despite these economic challenges, Sterling climbed by a cent against the dollar and spiked against the euro, indicating a degree of investor confidence in the UK economy. Governor Andrew Bailey stated that any subsequent rate cuts must be done 'gradually and carefully' to ensure monetary policy remains forward-looking and sustainable.
[1] Bank of England's Inflation Report [2] Speech by Andrew Bailey, Governor of the Bank of England [3] Minutes of the Monetary Policy Committee meeting [4] Office for National Statistics (ONS) employment data [5] ING Bank's Economic Research Department report
- In light of the Bank of England's concerns about persistently high inflation and the split MPC vote, some businesses may be reconsidering their investment strategies, particularly those in the mortgage sector, considering the potential impact of future interest rate changes on borrowing costs.
- Given the Bank of England's cautious approach to further interest rate cuts, insurance companies might find it beneficial to reassess their financial strategies, aiming to capitalize on potential opportunities arising from the uncertain interest rate landscape and manage risks associated with inflation.
