Key takeaways from the BoE's interest rate cut
In a closely watched decision, the Bank of England has cut its key interest rate for the first time since 2020, marking a tentative shift in its battle against inflation. The Monetary Policy Committee (MPC) voted by a narrow 5-4 margin to reduce the Bank Rate by 0.25 percentage points to 5%, a move that signals both progress in taming inflation and ongoing concerns about economic resilience.
Governor Andrew Bailey described the decision as “finely balanced,” reflecting the complex economic landscape the Bank must navigate. “Inflation has been exactly on our 2% target for two consecutive months. And inflationary pressures in the UK economy have eased much as expected. This is very welcome news,” Bailey stated.
However, he was quick to temper this optimism with a note of caution: “At the same time, the UK economy has been stronger in recent months. This is very welcome too. But it adds to the risk that inflation could be higher than expected if we cut interest rates too much or too quickly.”
This decision marks a pivotal moment in the UK’s monetary policy trajectory. After an aggressive tightening cycle that saw rates rise from near-zero to 5.25%, the Bank is now cautiously pivoting towards easing. Yet the split vote and careful messaging underscore the delicate balance the MPC is trying to strike between supporting economic growth and ensuring inflation remains under control.
The UK economy has shown surprising resilience in recent months, with GDP growth of 0.7% in both the first and second quarters of 2024. This strength, while positive for households and businesses, presents a dilemma for policymakers. As Bailey noted, “We need to make sure that inflation stays low. We need to put the period of high inflation firmly behind us. And we need to be careful not to cut rates too much or too quickly.”
The labour market, a key focus for the MPC, continues to gradually loosen but remains tighter than historical norms. Wage growth, while moderating, is still elevated at 5.6% annually. This persistent wage pressure is a significant factor in the Bank’s cautious approach to easing policy.
Perhaps the most concerning indicator for the MPC is services price inflation, which remains high at 5.7%. This metric is seen as a key gauge of domestic inflationary pressures and has proven sticky despite the overall fall in headline inflation. The Bank’s Chief Economist, Huw Pill, has previously highlighted this as a critical area of focus for policymakers.
Looking ahead, the Bank’s projections paint a mixed picture. Inflation is expected to rise again in the short term, with Bailey noting, “We expect consumer price inflation to edge up again in the second half of the year, perhaps to around 2¾%.” This anticipated increase is largely due to base effects as past energy price declines fall out of the annual comparison.
However, the medium-term outlook is more benign. The Bank’s modal projection shows inflation falling below the 2% target in two to three years, based on the current expected interest rate path. Yet the MPC has emphasized significant upside risks to this forecast, particularly related to the persistence of domestic inflationary pressures.
This risk of inflation persistence is at the heart of the MPC’s cautious approach. As Bailey explained, “The Committee continues to pay close attention to services inflation as an indicator of persistence in domestic inflationary pressures, along with a range of other economic indicators.”
The decision to cut rates now, despite these ongoing concerns, reflects a judgement that the risks of persistently high inflation have moderated sufficiently to warrant a slight easing of policy. However, the Bank has been clear that monetary policy will need to remain restrictive for some time to ensure inflation returns sustainably to target.
This stance was reinforced in the statement: “Monetary policy will need to remain restrictive for sufficiently long until the risks to inflation remaining sustainably around the 2% target in the medium term have dissipated further.”
The global context adds another layer of complexity to the Bank’s decision-making. While several major central banks, including the Federal Reserve and European Central Bank, have signaled potential rate cuts later this year, the Bank of England is among the first to actually implement a reduction. This move will be closely watched by other central bankers for its impact on inflation and economic activity.
For UK households and businesses, the rate cut offers some relief after a prolonged period of rising borrowing costs. However, the Bank’s messaging suggests that any further easing is likely to be gradual and data-dependent.
The reaction in financial markets has been relatively muted, suggesting that the decision was largely priced in. The pound sterling saw a slight depreciation against major currencies following the announcement, while UK government bond yields edged lower.
As the UK economy navigates this new phase of monetary policy, all eyes will be on upcoming economic data. The Bank has made it clear that it will remain vigilant and ready to adjust policy as needed. “The Committee continues to remain highly alert to the risks of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting,” Bailey emphasized.
In conclusion, while this rate cut marks a significant milestone in the UK’s post-pandemic economic journey, it is far from the end of the story. The Bank of England is treading a narrow path between supporting growth and guarding against inflation resurgence. As Bailey put it, “The best and most sustainable contribution monetary policy can make to growth and prosperity is to ensure low and stable inflation – and an economy where people can plan for the future with confidence and in which money holds its value.”
The coming months will be crucial in determining whether this cautious pivot marks the beginning of a sustained easing cycle or merely a brief respite in the ongoing battle against inflation.