(Bloomberg) — The Bank of England rekindled speculation about an interest rate cut in the near future, as more officials signaled they might support moving away from borrowing costs that are at a 16-year high.
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Investors are pricing in a more than 50% chance of a rate move in August, the first time they have been this confident in more than a month. The Bank of England kept rates unchanged at 5.25% on Thursday but said the decision not to ease was a “delicate balance” for some of the nine members of its Monetary Policy Committee.
Governor Andrew Bailey said it was “good news” that inflation had fallen to its 2% target for the first time in nearly three years, but that officials wanted to be sure price pressures were under control before acting. With price pressures fading and unemployment rising, there is growing speculation the central bank may back away from interest rate policies aimed at tamping down demand.
“This is clearly a dovish hold,” said Neil Jones, foreign exchange sales manager for financial institutions at TJM Europe. “Bailey’s comments suggest in some quarters that they are getting closer to a rate cut.”
The policy committee voted 7-2 for a second consecutive session to leave rates unchanged, with Governor Swati Dhingra and Deputy Governor Dave Ramsden both backing another rate cut, but the majority was divided on the significance of recent data showing services inflation had held up surprisingly well, according to minutes released by the Bank of England in London.
The minutes suggest three MPC members, possibly including Mr Bailey, are moving closer to cutting interest rates, which have remained unchanged since September last year. Recent comments suggest Mr Bailey, Deputy Governor Sarah Breedon and Deputy Governor Ben Broadbent may be in that camp, although Mr Broadbent is leaving the committee this month.
While formal guidance to investors has not changed, some rate-setters have said the decision is on the line, which could further strengthen support for an August rate cut.
Bloomberg Economics’ take…
“The Bank of England is close to cutting rates, and the lack of any apparent alarm over the recent inflation surprise suggests an August rate cut is certainly on the table.”
—Dan Hanson and Ana Andrade, economists at Bloomberg UK. Click here to REACT
The minutes said some members believed the recent data “would not materially alter the deflationary trajectory the economy has been on,” suggesting that Bank of England officials are increasingly comfortable starting to cut interest rates that the committee says are weighing on the economy.
Others point to risks from persistent domestic price pressures in the services sector, despite headline inflation falling to the Bank of England’s 2% target in May for the first time in almost three years.
“The fact that the decision at this meeting was a delicate balance for some members who voted to keep rates on hold suggests they may be less determined to vote for a rate cut in August unless wage growth and services inflation slow significantly,” said Thomas Pugh, economist at RSM UK.
Traders took the statement as a signal that the Bank of England intends to cut rates in the coming months, raising the probability of an August rate cut to more than 50% from 32% before the meeting. The market also raised its forecast for the number of rate cuts this year to almost two quarter-points.
“The Monetary Policy Committee appears to be gearing up for a late summer rate cut,” said Matthew Landon, global market strategist at JPMorgan Private Bank. “Whether the cut comes in August or September, the market will need to bring forward the expected easing and push down yields.”
Bonds rose and the pound fell as markets adjusted expectations. The yield on the two-year government bond, the most sensitive to changes in monetary policy, fell five basis points to 4.13%, the lowest since the end of March. The pound was down 0.3% to trade at $1.2680.
“The August meeting could remain volatile as there is still a lot of data for the market to see ahead of the next meeting,” said Puja Kumra, head of European rates strategy at TD.
Not everyone is convinced that an August rate cut is a certainty. Markets will have to sift through next month’s inflation report, wages data and purchasing managers’ index report, all of which could reignite concerns about the outlook. Inflation is back up to the Bank of England’s 2% target, but services inflation and wage growth are both still too high.
Speaking for the committee, Bailey urged caution in explaining why the committee decided not to make any changes this month.
“We need to ensure that inflation remains low so we have decided to keep interest rates unchanged at 5.25 percent for the time being,” Bailey said in a brief statement.
Those were the only comments from Bank of England policymakers since Chancellor Rishi Sunak called a general election for July 4. Bank of England policymakers remained silent during the election period, meaning investors went into their June meeting with little information from officials about how recent disappointing data was affecting the financial community’s thinking.
Bank of England officials have grown increasingly optimistic about slowing inflation and the possibility of cutting interest rates, but markets have been abuzz in recent months about the timing of any rate cuts.
At the start of the year, investors were pricing in up to six quarter-point cuts this year, but more recently they are now expecting no cuts until November, reflecting stronger-than-expected inflation in the U.S. and U.K. over the past few months and the Bank of England’s lack of comment since Governor Sunak called a general election.
Bailey was seen as one of the rate-setters closest to cutting rates before rising underlying inflation measures and the election dashed hopes of a cut in June.
Inflation has fallen to the Bank of England’s 2% target but market expectations of a rate cut in 2024 have faded in recent months as wages and services prices, key indicators closely watched by policymakers, continue to rise.
Acting in August would put the Bank of England close to matching the timing of the European Central Bank, which began easing monetary policy earlier this month. Traders expect the U.S. Federal Reserve to wait until later in the year, and the central banks of Canada and Switzerland have also started cutting borrowing costs.
The BOE said it expects second-quarter GDP growth to pick up significantly following the economy’s sharp recovery from last year’s recession, and it raised its second-quarter growth forecast to 0.5% from a 0.2% forecast in May, continuing the strong start to the year.
The upward revision is based on business surveys. The UK economy rebounded from last year’s recession with a robust 0.6% growth in the first quarter, but April data showed the recovery is stalling. Private sector forecasters now see growth rising to a still-anemic 0.7% in 2023 from 0.1%.
“While we expect the MPC to cut rates in August, this is not a given,” said Alpesh Pareja, interim deputy chief economist at CBI. “They remain highly data-driven, so how key indicators perform over the next month will be key. Moreover, the pace of rate cuts beyond August is likely to be gradual.”
–With assistance from Alice Atkins, James Hirai, Aline Oyamada, and Alice Gledhill.
(Updates with market reaction and comment in first paragraph.)
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