MPC meeting: rate cut as expected, but future cuts trickier
In a widely anticipated move, the Bank of England (BoE) chose to cut interest rates to 4% from 4.25% at its latest meeting on the matter. However, with the vote split 5-4 in favour of a cut, the decision was much closer than most commentators had expected. We still expect one more rate cut this year because the Monetary Policy Committee (MPC) maintained its Ҵýgradual and carefulҴý guidance and the labour market looks set to continue weakening. However, there is a significant risk the MPC will choose to pause or even end this latest series of cuts if there are signs the labour market is improving or the upcoming Autumn Budget looks inflationary.
What does the latest cut tell us about where interest rates go next?
The most interesting part of todayҴýs decision was the 5-4 vote split in an unprecedented second-round vote, where five members voted for a cut and four for a hold. This was after a 4-4-1 tie in the first vote, including one member angling for a 50bps cut.
We had expected just two members to vote for a hold. WhatҴýs more, the BoE raised its inflation forecast to 4%, combining that with an acknowledgement that ҴýҴý. This puts a decidedly hawkish tint on AugustҴýs rate cut and raises the chances that the MPC chooses to skip a cut in Q4.
However, thereҴýs still a clear split on the committee as the MPC tries to balance sticky inflation and householdsҴý rising perception of inflation with a clearly weakening labour market. Indeed, despite the overall hawkish shift, one member of the committee still thought that a 50bps cut was justified as payrolls continue to point to falling employment.
The four members that decided to vote for a hold emphasised concerns that rising food and energy prices not only raised the outlook for inflation in the near-term, but also that Ҵýthe risk of inflation expectations feeding through to second-round effects had risenҴý. Translating this from central bank speak, the hawks are clearly worried that the rising costs of essentials, which all households will notice, will prompt people to bargain for bigger pay rises to protect their real incomes. Meanwhile, firms may try to pass-through price hikes to consumers to protect their margins in response to rising prices. This would keep inflation higher than both we and the MPC currently expect.
Turning to the doves, the majority of the MPC clearly still believe disinflation is continuing enough to justify further rate cuts. The labour market keeps loosening and pay growth has noticeably slowed over the second quarter, undershooting the MPCҴýs expectations. Indeed, Bank of England Governor, Andrew Bailey, said in the press conference, Ҵýthe one thing that is apparent is that pay has come in lower than we thought it wouldҴý.
Will there be another interest rate cut in 2025?
As the MPC looks towards the rest of its meetings this year, the committee will have to continue to balance inflation that is heading towards 4% and double the 2% target with a clearly weakening labour market and sluggish growth.
We believe that the labour market will continue to loosen over the rest of the year as firms complete their adjustments to increased employment costs. A greater degree of slack is clearly already feeding through into slower pay growth. This should provide the MPC enough cover to cut interest rates again in November.
However, one of the MPCҴýs scenarios highlighted the risk to inflation from rising energy prices due to conflict in the Middle East. This continues to show upside risks, despite oil prices falling back recently. WhatҴýs more, the MPC now believes food inflation will peak at 5.5% and is clearly worried that households will respond to rising food and energy costs by bargaining for bigger pay rises. This could cause the disinflation process to stall.
WhatҴýs more, thereҴýs a risk that in the Autumn Budget the government announces another round of duty and regulated price increases, which would prevent inflation falling back below 3% in 2026 as we currently expect. This could be enough to justify a pause in rate cutting.
Yet, higher taxes reduce demand in the economy because money is pulled out of householdsҴý and businessesҴý hands. The MPC would usually be able to offset this with interest rate cuts. However, duties are stagflationary because not only do they represent a negative demand shock, but they also increase inflation, which could complicate the MPCҴýs response. The MPC would ordinarily look past a one-off increase to prices from duties and focus instead on offsetting the growth impact. However, after almost five years of above-target inflation, the MPC may have no choice but to step in to weigh on inflation.
On balance, the MPC chose to maintain its Ҵýgradual and carefulҴý guidance, which suggests the outlook for one more cut remains intact as the labour market continues to ease. That said, the likelihood that this cut in August was the last of the year has risen sharply as the MPC wrestles with 4% inflation.
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