The Bank of England has cut interest rates for the first time since the Covid pandemic, from a 16-year high of 5.25% down to 5%. Cuts are justified now that inflation has fallen back to target, the bank’s Monetary Policy Committee (MPC) said.
“The impact from past external shocks has abated and there has been some progress in moderating risks of persistence in inflation. Although GDP has been stronger than expected, the restrictive stance of monetary policy continues to weigh on activity in the real economy, leading to a looser labour market and bearing down on inflationary pressures,” the MPC explained.
Committee members were almost evenly split on what course of action to take. Five people voted for cuts versus four members preferring to stay higher for longer, not least because the risk of inflation resurgence has not entirely dissipated.
Although annual CPI inflation hit the MPC’s 2% target in May and June, it is expected to increase during the second half of 2024 as last year’s energy price declines fall out of the annual comparison.
“Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further,” the MPC warned.
Zara Nokes, global market analyst at JP Morgan Asset Management, said: “With headline inflation back at the 2% target for two consecutive months, the Bank likely saw this as too tempting an opportunity to turn down to take its foot off the brake.”
She expects the cutting cycle to be “relatively gradual, with a quarterly cadence seeming plausible” as “optics” around further rate cuts could become more challenging, with headline inflation likely to pick up again later in the year as favourable energy base effects fade.
“This, coupled with ongoing resilience in economic activity, and the implications of recently announced public sector settlements on wage growth more broadly, will likely temper how quickly rates are cut going forward,” she explained.
Rob Morgan, chief investment analyst at Charles Stanley, agreed. “We will likely see a shallow trajectory of cuts, perhaps at a roughly quarterly pace, towards the 4% level next year. There could be a faster cutting cycle only if growth disappoints or inflation becomes more firmly subdued, which looks unlikely,” he said.
Fed stands pat
The BoE’s decision puts it on a divergent path to the Federal Reserve, which opted to hold US interest rates at 5.25% to 5.5% yesterday, as expected.
Chair Jay Powell implied that rate cuts could be introduced as early as September, now that inflation is on a more sustainable path towards the 2% goal.
Gerrit Smith, manager of the Stonehenge Fleming Global Best Ideas Equity fund, said: “The Fed’s new language of the first cut being nearer is a signal of confidence that US inflation is well under control.”
However, Daniele Antonucci, chief investment officer at Quintet Private Bank, believes that markets are being too optimistic in pricing in three rate cuts by year-end. “We think it's more realistic to expect up to two cuts, with the Fed starting to move lower at a measured pace,” he said.