Markets were almost certain that the Bank of England (BoE) would cut interest rates in August. The bank had previously indicated that this would be the case. However, hopes of a rate cut in the summer were dashed after inflation proved more stubborn than hoped last month.
To curb the rise in consumer prices, interest rates were kept at a 16-year high of 5.25%. But the higher rates have also pushed up borrowing costs, including mortgages.
After inflation finally hit the Bank’s 2% target in May, markets were almost certain that a rate cut would occur in the summer. However, the fact that inflation remained at 2% in June despite forecasts of a further decline has led investors to temper their expectations of a rate cut in August.
According to money markets, the probability of the BoE cutting interest rates next month is less than 25%, with inflation remaining stable at 2%.
Traders have significantly reduced their bets on a reduction in borrowing costs at the next meeting of the Monetary Policy Committee (MPC) on August 1.
On Tuesday, the probability of a rate cut was around 49 percent; at the end of last week it was 51 percent.
Jonathan Haskel of the BoE also dampened the City’s forecasts when he recently said inflation was expected to rise again above the BoE’s 2% target.
“I would prefer to keep interest rates on hold until there is greater certainty that underlying inflation pressures have subsided in a sustained manner,” Haskel, a member of the bank’s MPC, said in a speech at King’s College in London on Monday.
Haskel is an external member of the MPC and his term ends on August 31. While some members of the bank’s nine-member MPC have pushed for a reduction in official borrowing costs in recent months, Haskel has voted to keep interest rates unchanged.
Read more: Inflation in British food retail at lowest level in almost three years
“The impact of these shocks on the economy and the continued tight and impaired labor market mean that inflation will remain above target for quite some time,” Haskel said.
Bank Governor Andrew Bailey had previously stressed that inflation must be sustainably close to the target before the bank takes action.
Significantly, the much-watched inflation in the services sector, which covers categories such as hospitality, culture and housing, remained unchanged at 5.7 percent in June, higher than economists had estimated.
The core inflation rate, which excludes energy, food, alcohol and tobacco, remained at 3.5 percent.
Experts warn that a rate cut this summer is less likely unless the MPC majority is confident that inflation is under control.
Peter Arnold, chief economist at EY UK, said: “The minutes of last month’s MPC meeting made it clear that the committee is divided. The more warlike members may see today’s data as evidence that their concerns about persistent inflation are well founded.
“The implications for the more dovish members are unclear. On the one hand, they indicated that they were less interested in backward-looking measures of inflation persistence and instead pursued a more forward-looking approach.
“And this change in policy has come despite a series of overshoots in services inflation. On the other hand, from a presentation perspective, they may feel they need to wait for inflation to surprise lower before acting. An aggressive market reaction to today’s data could also encourage the MPC to take a wait-and-see approach.”
Read more: British inflation unchanged at 2% in June
Although it remained at its lowest level since 2021 and within the Bank of England’s target range, inflation was higher than economists’ estimates of a decline to 1.9%.
Anna Leach, chief economist at the Institute of Directors, said: “The Bank will be relieved that headline inflation remained at target in June, in line with its expectations.”
“However, this relief is tempered by services sector inflation remaining at 5.7%, well above expectations. Stagnant services sector inflation – a key indicator of domestic inflation pressures – reduces the likelihood of a rate cut in August.”
There are signs of rising inflation around the world, with the US Federal Reserve postponing its interest rate cuts and the European Central Bank raising its inflation forecasts for the rest of the year.
The BoE forecasts that inflation will be 2.5 percent by the end of 2024 and that prices will not rise sustainably to 2 percent until early 2026.
Sam North, analyst at investment platform eToro, said: “The BoE hawks are winning. UK inflation held steady at 2% in June, slightly above expectations, driven by rising hotel and restaurant prices, while clothing prices fell. This ongoing inflation reduces the likelihood of a rate cut in August and markets are reacting cautiously. Further wage data on Thursday will be crucial in shaping future monetary policy decisions.”
However, some economists are calling for a rate cut as inflation remains stable at the BoE’s target of 2%.
George Dibb, deputy director of economic policy at IPPR, said: “Today’s data confirm that inflation is well on its way to normalising. Some inflation drivers, such as core inflation, are still high, but the Bank of England’s monetary policy remains too restrictive. Interest rates have been too high for too long and need to be reduced to avoid hampering growth.”
Another variable on the table in Threadneedle Street is the new UK government’s promise to make the minimum wage a “real living wage”. This follows a nearly 10% increase in the lower wage threshold in April.
Read more: What the new Labour government means for your money
The party has declared that it will fully implement its “New Deal for Working People” within its first 100 days.
“Labour’s pledge to introduce a ‘real living wage’ suggests the possibility of stronger wage growth and some risk of slower rate cuts, but the magnitude of the change remains uncertain,” said James Moberly and Sven Jari Stehn, economists at Goldman Sachs.
The Bank of England warned in June that the increase in the national living wage in April “could have a larger impact than expected”.
Some are certain that a rate cut will happen. One money market trader, for example, has bet £2 million that the BoE will make the biggest rate cut in four years next month.
According to Bloomberg, the retailer could make a net profit of £8 million if policymakers cut borrowing costs by half a percentage point in August, from 5.25 percent to 4.75 percent.
The last time the BoE cut its key interest rate by half a percentage point was in the days following the first Covid lockdown in the UK in March 2020. At that time, it reduced borrowing costs from 0.75% to 0.25%.
The Bank of England will announce its interest rate decision at around midday on August 1. It will be accompanied by a quarterly monetary policy report presenting new forecasts and a press conference at which Bailey will speak for the first time since the general election.
Download the Yahoo Finance app, available for Apple And Android.
