Bank of England to Cut Rates in August?

At its meeting on Thursday, the 19th of June, the Bank of England decided to stall its key interest rate, keeping it at 4.25%. Out of the nine members, three have voted for a 25-basis-point cut and the majority of six have opted to hold rates. Many economists expect that the BOE will continue cutting rates in August.

This move was widely expected for June. The world was already in a tense geopolitical situation before the Israel-Iran conflict. That conflict has only made things worse. The new conflict and fears of the US pulling back on support for Ukraine are causing market tensions and are fuelling negative emotions. On a global economy level, Trump’s looming tariffs threaten to disrupt key partnerships and shift trade balances significantly.

The BOE reemphasised its previous notion, stating that “given the outlook, and continued disinflation, a gradual and careful approach to the further withdrawal of monetary policy restraint remains appropriate.” This timid stance serves to avoid an excessive commitment to aggressive cuts until “the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further.”

In general, the MPC, the BOE’s deciding committee, wishes to remain sure that its policy matches the “heightened unpredictability” present in both domestic and global conditions.

However, that does not mean that the outlook is bleak. Disinflation is pressuring the UK, and the labour market has shown a poor performance. As such, a move to spur the economy may prove imminent, while already lining up with the BOE’s eventual goal of returning inflation to around 2%, and yearly goal of rates slipping below 3.75%.

The UK’s current position

The UK has had a somewhat concerning performance in April, with the economy shrinking by 0.3%. This wiped out much of the progress the UK made earlier in the year. The economy had expanded by 0.7% across January, February, and March.

The labour market has also shown a retraction. Vacancies have dropped significantly, losing 5.3% compared to the previous quarter. With the current figure at 761,000, the market is underperforming even pre-pandemic numbers, and by 4.3%. Year-on-year, this marks a 14.7% decline, with the UK experiencing a long streak of disappointing quarterly labour market performance. The unemployment-to-vacancy ratio with this data is at 2.1, up from 1.9 last quarter.

Further building pressure, unemployment levels are rising with wage growth staggering. All of this indicates that the market is in need of a jolt. However, the BOE is vigilant in ensuring that any cut is done properly, within the right global and domestic context.

What happened at the BOE meeting

Three of the nine BOE members voted for a rate cut, shifting the balance toward the dovish side. Dhingra, Ramsden, and Taylor were the MPC members that favoured a 25bp rate reduction. This surprised some who were expecting a 7-2 split and was a potential signal of a degree of urgency coming from the MPC.

There are clear signs that “a margin of slack” has been created, said UK’s central bank in a statement. It is concerned with GDP growth remaining shoddy, and the labour market’s prolonged exhaustion.

Another particular pain point is pay growth. As noted, it weakened compared to the previous period and is expected to slow further. As such, the MPC stated that it “remains vigilant about the extent to which easing pay pressures will feed through to consumer price inflation.”

Next, there’s an unignorable increase in global uncertainty. Concerns of energy deficiency arose with the new Israel-Iran conflict, with the risk of Iran, a major oil producer, becoming unable to deliver energy materials to its importers. Another risk is the potential blockage of the Strait of Hormuz, a major chokepoint for Gulf energy exporters. A prolonged stoppage may lead to difficulties in global energy supplies.

Economists highlighted that a degree of caution and flexibility is crucial. If oil supplies were to plummet, for instance, the inflationary pressure may make rate cuts impossible unless they were to break the backs of consumers. In such a scenario, the MPC may even be expected to halt its rate cut plan altogether and transition to a hawkish stance.

Incoming rate cuts?

Amid the building pressure on the UK economy, experts, including economists polled by Reuters, predict a 25 bps rate cut in the following quarter. Furthermore, they expect that to be followed by another 25 bps cut in the final quarter of the year. However, there is some difficulty in predicting the BOE’s strategy.

The global uncertainty and the speed and unpredictability at which these events happen are making specific predictions difficult. Still, the BOE has shown clear signs that, by the end of the year, they would like rates to hover slightly below 4%. Additional encouragement comes from the UK’s overnight swaps market, which is now estimating an 84% chance of a cut on the 7th of August.

Market reactions; what a rate cut could imply

With no actual action taken the results after the meeting on Thursday were fairly dull. EUR/GBP showed a slight increase, but nothing alarming for the forex market. The FTSE 100, the UK’s primary benchmark index, reacted sharply, losing much ground on Thursday’s close but recovering all of that and trending upwards on Friday.

However, these muted reactions are to be expected. In general, when releases yield expected results, markets tend to ignore them and move on to other factors. Still, if rate cuts were to arrive in August, the market could show a more significant reaction.

With rate cuts, spending is encouraged over saving, and borrowing becomes cheaper. While this creates a positive sentiment, fixed-income assets like bonds benefit the most.

For traders, FTSE 100, GBP/EUR, and other minor and exotic pairs that use the pound sterling are worth watching. The deciding factor in their movement, if the rate cuts do come, will be what the surrounding context is. In a positive climate, rate cuts boost sentiment. However, if the UK keeps struggling, rate cuts may indicate recession fears, causing volatility and investor uncertainty.

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