The Bank of England has today cut interest rates to 5%, marking the first reduction in interest rates since 2020. The decision, made during the Monetary Policy Committee (MPC) meeting, was passed by a narrow majority vote of 5-4. The rate was reduced by 0.25 percentage points from its previous level of 5.25%. The vote revealed a division among policymakers. BOE policymakers Pill, Greene, Mann, and Haskel voted to keep rates on hold, while Governor Andrew Bailey, along with Breeden, Lombardelli, Ramsden, and Dhingra, supported the rate cut.
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Market Response
The market’s reaction to the Bank of England’s rate cut was relatively subdued, indicating that the decision had been largely anticipated by participants. The GBP/USD exchange rate, already down on the day, showed little movement following the announcement at 12:00 noon, suggesting that traders had priced in the expected 0.25 percentage point rate cut in advance. However, once the market processed the commentary by Andrew Bailey in the press conference afterward, sterling extended its losses as participants adjusted for the new possible trajectory of interest rates in the UK.
In the bond market, UK 2-year treasuries experienced a decline of around 1% today, reflecting the market’s adjustment to the new interest rate environment. The 10-year treasuries were also down, albeit by a smaller margin of approximately 0.5%. These movements in the bond market highlight a reassessment of future interest rate trajectories and inflation expectations.
Equity markets initially responded more positively to the news. The FTSE 100 index rose by 0.23%, with notable performances from Rolls-Royce, Next, and Smith & Nephew, which were the top three performers in the index at the time. However, as the day progressed, the overall gains on the FTSE 100 were given back, suggesting a possible reallocation within the index itself.
Overall, the market’s response suggests that it is adjusting to a new trajectory of interest rates and the possibility that the Bank of England might be lagging in terms of reducing rates. However, the only way to confirm this will be by analysing more inflation data over the coming months.
Inflation Outlook
Inflation remains a pivotal factor in the economic outlook. The Bank of England expects inflation to rise to 2.25% towards the end of the year, primarily because the negative contributions from household energy costs will fade out of the reading. Following this rise, inflation is expected to revert back towards the 2% target over the subsequent 12 months. This expectation should help the market avoid overreacting if inflation rises slightly. However, if inflation significantly exceeds the 2.25% expectation, it could create concerns about persistent inflation. Consistent inflation control will help avoid adverse market reactions to any potential spikes. If inflation were to rise again, it could prompt the Bank of England to tighten monetary policy further, which might counteract the efforts to stimulate the economy.
Conversely, if inflation falls too low, there is a risk that the Bank of England could fall behind in adjusting interest rates appropriately. An excessively low inflation rate might necessitate more aggressive rate cuts in the future, which could destabilise economic planning and market expectations.
Bank of England Governor Andrew Bailey emphasised the need for a cautious approach, stating, “We need to be careful not to cut rates too much or too quickly, all the while monitoring evidence on how inflationary pressures are evolving.”
Furthermore, while core goods inflation is expected to decrease, services inflation is anticipated to come down at a slower pace. This divergence in inflation trends highlights the varying dynamics within different sectors of the economy and the need for targeted policy measures.
Future Outlook
Looking ahead, the next significant catalyst for the UK economy will be Rachel Reeves’ upcoming budget. This budget is expected to play an essential role in shaping the economic landscape amid mounting fiscal challenges. With UK government debt to GDP approaching 100%, and Reeves already highlighting a larger-than-expected black hole in the government’s finances, it is likely that further spending cuts and tax increases will be necessary to address the fiscal deficit.
The specifics of Reeves’ budget will be closely scrutinised. Key areas of interest will include potential spending cuts across various sectors and the nature of tax adjustments aimed at boosting government revenues. The effectiveness of these measures in balancing the budget while fostering economic growth will be vital. Market participants will be particularly attentive to how these fiscal policies align with broader economic objectives, such as sustaining growth and maintaining employment levels.
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