Bank of England cuts rates to stop UK slowdown turning into a slump

The Bank of England cut its key interest rate by a quarter-point to 4 percent, but it warned that stubborn inflation is limiting its ability to give any more support to an economy still struggling to get out of first gear.

Governor Andrew Bailey told a press conference that while he still believes the path of interest rates is headed downward, there’s now “genuine uncertainty” over the future course of rates. His comments came after the Bank published new forecasts showing that inflation may hit 4 percent in September — twice the official target — and won’t come back to 2 percent until the middle of 2027.

That’s a bleak message for a government that has been hoping for lower rates to juice the economy, and an equally bleak one for consumers and businesses that are still digesting the more violent inflation shock of three years ago. A crumb of comfort came from a modest upward revision to the Bank’s growth forecast, which now sees the U.K. economy expanding by 1.25 percent this year, up from a projection of 1 percent three months ago.

Cold comfort for Reeves

Chancellor Rachel Reeves was quick to take the move as fresh proof that its efforts to shore up the public finances are bearing fruit, stressing that rates were now at their lowest level in two years.

However,  Laith Khalaf, director of investment strategy at AJ Bell, said the move was cold comfort for the chancellor, and wouldn’t make any difference to Office for Budget Responsibility forecasts showing another black hole emerging ahead of the Autumn budget.

“There’s now probably only one interest rate decision before the Budget where a cut could provide a windfall for the chancellor, and markets are pricing in very little chance of any action from the Bank of England in September,” Khalaf said.

He added the cut will do little to help homeowners either: the yield on the two-year U.K. government bond, or gilt, which forms the benchmark for the most popular mortgage product in Britain, actually rose by 0.05 percent as markets reduced their bets on future rate cuts.
Indeed, while the cut had been widely expected and was consistent with a “gradual and cautious” approach to relaxing policy, it nearly didn’t happen at all: four of the nine-strong Monetary Policy Committee voted not to cut, including Deputy Governor Clare Lombardelli and Chief Economist Huw Pill. That was “a stark reminder that future cuts are not assured,” said Anna Leach, chief economist wit the Institute of Directors.

Others, led by Shadow Chancellor Sir Mel Stride, rushed to argue that Reeves’ own budget from last year was largely responsible for the Bank having to adjust its stance.
“Interest rates should be falling faster, but Labour’s Jobs Tax and reckless borrowing have pushed inflation well above target,” Stride said.

Food inflation rears its ugly head

A large part of the Bank’s increased caution was due to food prices, which rose at an annual rate of 4.5 percent in June, broadening a problem that for much of the last two years has been largely confined to services.

“Food and energy prices are salient to consumers and often affect consumer expectations more than any other prices,” Bailey explained, “so we have to be very careful that this does not lead to any additional second-round effects on wage and price-setting in the economy.”

While he and Lombardelli talked up the effects of global commodity prices, especially for items such as coffee and cocoa, the Bank’s new Monetary Policy Report also acknowledged that part of the rise in food prices was due to government decisions to raise National Insurance contributions, the National Living Wage and administered prices such as those for water and energy. The British Retail Consortium’s chief executive Helen Dickinson noted that the MPR “outlines how the last Budget continues to push up food prices,” asserting that  government policy — including a new packaging tax levied on companies — will add £7 billion to retailer costs this year.

Despite a visibly higher level of angst, financial markets still expect another two cuts from the BoE before it stops easing policy. However, analysts said the chance of both of those cuts coming this year has now fallen.