The Bank of England has just announced a rate cut of 0.25 percentage points, reducing the base rate from 5.25 per cent to 5 per cent. The tight decision – voted 5-4 by the Monetary Policy Committee – is the first reduction in rates since March 2020. It starts what is likely to be a slow and steady process of reducing the base rate, and marks the end of the inflation crisis, which saw Threadneedle Street hike rates from the floor to a 16-year high over the course of twenty months.
Financial markets were cautiously expecting a rate cut, but the decision was thought to be on a knife-edge. It turns out it was: the rate cut is small and the decision was close, with four members of the MPC voting to maintain the base rate. But it is nevertheless a very significant day for the BoE, as it indicates confidence that the headline inflation rate has returned to target for the foreseeable future.
Today’s report from the Bank suggests inflation will rise slightly towards the end of the year, to 2.75 per cent, but its models show the rate falling back down ‘to 1.7 per cent in two years’ time and to 1.5 per cent in three years, reflecting the continued restrictive stance of monetary policy and the emergence of a margin of slack in the economy'. Despite some fluctuation, it seems the MPC is confident enough that inflation is not at risk of spiking again anytime soon – allowing members to vote to reduce the base rate.
The Bank of England has played a very cautious hand on rates, after it so badly miscalculated the inflation crisis back in 2021. Threadneedle Street has been looking at wage data and services inflation specifically as major indicators for underlying pressures on inflation, but says in its minutes today that these pressures now ‘appear weaker’.
‘Private sector regular average weekly earnings growth has fallen to 5.6 per cent in the three months to May, and services consumer price inflation has declined to 5.7 per cent in June,’ the update reads. This is notably not a spectacular fall compared to previous months: these figures have remained sticky for some time, giving the Bank reason to keep rates on hold. But the gradual, continuous slowdowns finally tipped in the favour of a rate cut, as five members of the committee ‘finally balanced’ these risks, and decided they merited slightly reducing the base rate.
It’s a good day for homeowners, who may see a further reduction in mortgage rate offers after today’s decision (however they are likely to be small, as many rate offers had already baked in prospective rate cuts). It’s also a very good day for the Labour party. Regardless of other more positive economic indicators, rate cuts were always going to be necessary for people to start feeling the benefits of a stronger economy. While the Bank is still likely to lean to the hawkish side (reiterating today that ‘monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2 per cent target in the medium term have dissipated further’), the pressure of higher rates will now be easing, slowly, over the next year.
There’s more good economic news: the BoE has quite dramatically revised their growth forecasts for the year: an increase to 1.5 per cent, up from 0.5 per cent in their report from May.
These changes will no doubt lead to some political questions, including the Bank’s decision to hold off on rate-cutting until just after Labour entered Number 10. But we should be wary of politicking accusations. The Bank has been suggesting since the spring that a rate cut was coming in the summer – and once an election was called, that wasn’t going to be in June. While the BoE made a point to say in June that its decision to hold rates wasn’t about the election, central banks tend to stick to the status quo during such periods, as to make sure they can’t be accused of making a decision that favours one political party over another.
This meant that the first rate cut would likely be August or September – and benefit whoever was in charge. It was one of the reasons so many Tory MPs were baffled when the election was called for the summertime. The expectation was that summer would bring better economic news – and it did, including higher-than-expected growth rates in the spring, which have surely contributed to the BoE’s revisions (and serve as a reminder of how turbulent and shaky these forecasts tend to be).
While there hasn’t been a huge shift in the data the Bank tends to focus on, it has been saying for months that its ‘stance of monetary policy could remain restrictive even if Bank Rate were to be reduced, given that it was starting from an already restrictive level'. In other words, there was scope for cautious rate-cutting, even if the Bank remained cautious about inflationary pressures. That is the balance that seems to have been struck today.
Don’t expect a continuous series of rate cuts now. The BoE will want to see the impact of the first cut, and once again assess its indicators – including the Chancellor’s decision to approve inflation-busting pay raises in the public sector. Capital Economics forecasts this afternoon that the next rate cut won’t be until the November meeting.
But today’s small cut does mark a change of direction. It’s a welcome one for many.
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