6 August 2024
The Bank of England’s (BoE) Monetary Policy Committee (MPC) convenes approximately every six weeks to assess the economic landscape and determine the appropriate level of the UK’s base interest rate, the Official Bank Rate (OBR). This crucial decision aims to steer inflation towards the Central Bank’s 2% target. In a notable first, the August meeting of the nine-member committee was the first time female members outnumbered their male counterparts – unique for any major global central bank.
Over the last decade, never has such a degree of uncertainty clouded the likely outcome of the committee’s deliberations regarding the OBR, as we witnessed in this most recent meeting. This ambiguity was further fuelled by MPC members being barred from public speaking in the leadup to the election, making it hard to judge how opinions have developed.
For the first time since the start of the pandemic, the Bank of England’s (BoE) Monetary Policy Committee (MPC) decided to cut the Official Bank Rate (OBR) by 0.25%, ending the joint longest peak in rates since the BoE gained independence.
Inflation proving more persistent than expected
Economic data since the MPC met in June 2024 has indicated that inflation is proving to be marginally more persistent than the Central Bank had expected.
Consumer Price Inflation (CPI) was in line with the BoE’s 2% target in June, but services inflation (currently the key component of inflation for the BoE) remained at 5.7% - considerably higher than where market and BoE forecasts had expected. The chart below1, highlights why they now have such a focus on services inflation.
However, another indicator closely followed by the BoE - pay growth in the private sector - dropped to 5.6% in the three months to May, leaving it broadly in line with the BoE’s expectations. Additionally, the jobs market looks to be slowing, with unemployment rates trending towards around 4.5% at its next reading, 0.2% higher than the bank’s May forecast.
Given the lack of communication from policymakers during the election period and the inconclusive nature of economic data, the considerable uncertainty preceding the MPC's decision was unsurprising.
The decision
The MPC’s conclusion was to cut OBR by the slenderest of margins, with five members in favour and four against. The committee pointed out that there had been “some progress” in curbing the persistence of inflation and it appeared to downgrade the importance of individual overshoots in services inflation data and above trend wage increases.
The MPC said it expected this progress would lead to lower pay rises and would discourage firms from raising prices rapidly. However, there is a significant minority on the committee who did not share this view.
Governor Andrew Bailey was reluctant to declare victory in the fight against inflation, stating that they ‘need to make sure inflation stays low’ and that the BoE needs to ‘put the period of high inflation firmly behind us.’ Bailey also added that the UK economy had proven to be stronger in recent months – which brings the risk of higher inflation if rates are cut too much or too quickly.
Future path
Despite the cut in the OBR, the committee cautioned that monetary policy would need to continue to ‘remain restrictive’ for sufficiently long enough so that inflation is fully stamped out. This means that the BoE still views OBR at 5% as a constraint on economic output and over time there will be scope to lower rates further to support growth. That said, we think the reference to restrictive policy is a signal that any further rate reductions will be gradual.
The MPC offered no explicit guidance on the timing of subsequent rate reductions.
When the MPC meets in November, it will be in possession of another round of economic forecasting and there will have been three more crucial CPI and labour market data releases. This will likely be the next opportunity for the BoE to enact another 0.25% reduction in OBR, especially as we suspect MPC will put less emphasis on the temporary, energy-price - driven pick up in CPI later this year. By that point the BoE will also have taken the autumn budget into account. Currently there is uncertainty about how much additional borrowing will be required to boost spending on public services but once this uncertainty has passed, it may further assure MPC members that are currently concerned about inflation driven by fiscal policy.
Forecasting the trajectory of the OBR continues to be uncertain, particularly over extended horizons due to the potential impact of unforeseen geopolitical factors. That said, the MPC's latest inflation projections, which anticipate a decline to 1.7% and 1.5% in two and three years respectively, contingent on the market's projected OBR of 3.5% in three years, offer a potential framework for analysis.
We anticipate a gradual and measured reduction in the OBR over the next eighteen months, subject to the BoE's increasing confidence in the moderation of service inflation and wage growth.
1 Source: Bank of England’s August 2024 Monetary Policy Report.