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A Bank of England rate cut would surprise markets this week.
Time it was when rate cuts were the talk of late 2023 and early 2024, but as the next Monetary Policy Committee meeting approaches on Wednesday – with a subsequent announcement to follow on Thursday – a less sanguine mood has set in.
FactSet consensus now has interest rate expectations at 5%, implying no change. Other evidence points to the same conclusion.
"The chances of a further rate cut in September are slim, according to a recent poll of economists by Reuters, with almost all surveyed believing September is coming too soon after the recent rate cut," says Morningstar's European market strategist Michael Field.
"Markets seem to be pricing in one more rate cut, which is likely to come later in the year."
Interest rates in the UK currently sit at 5%, following the BoE's only cut of 2024 on August 1. House prices are at a two-month high, but elsewhere negativity has started to creep in to the data since the election.
Inflation ticked slightly higher to 2.2% in the 12 months to July and, after a busy summer of public events and decent weather, there may not be a re-commencement of the downward trend politicians traded off at the July general election.
The government's first Budget on October 30 is likely to include a number of tax rises, and the prime minister is preparing the country – and his own MPs – for economic pain. Naturally, the Bank of England remains politically neutral, but it too is managing expectations.
"Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further," the BoE said in the statement accompanying its August 1 rate cut.
"The [MPC] continues to monitor closely the risk of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting."
For observers, this "we reserve the right"-style statement has become all too familiar. While markets expect a gradual loosening on monetary policy in the coming years, there is no set timetable, as the Bank is keen to stress.
"We have to be careful not to cut interest rates too much or too quickly," it said in the August 1 statement. The Bank forecasts interest rates being around 3.5% in the latter half of 2027 – three years away.
Why Might The Bank of England Pause its Rate Cuts?
The BoE's August 1 rate cut was its first since the panicked days of the pandemic in 2020: a milestone, but not one to celebrate. Some already saw caution coming.
"While the immediate decision to cut was slightly dovish versus market expectations, the overall guidance and statement were more neutral, with the MPC showing no urgency to cut rates from here," said Peder Beck-Friis, an economist at Pimco, in a note in August 2024.
"Looking ahead we expect the Bank to proceed cautiously from here. We think another cut in September is unlikely, unless incoming inflation and labour market prints surprise to the downside, and expect the next cut in November as a baseline."
The next UK CPI print from the Office for National Statistics is due on September 18. That will be a central talking point when the BoE's MPC meets that day.
Last month's figures, which covered the 12 months to July 2024, showed an inflation rate uptick to 2.2%, just slightly above the BoE's target of 2%. Chief among the drivers of slightly higher price increases was housing and housing services.
The Dynamics of Inflation and Economic Growth
Recent figues on UK jobs, wages and GDP did not show an economy overheating.
"The reasons why the Bank might decide to hold its interest rate at 5% can be determined by the dynamics of inflation and growth," says Morningstar Wealth associate portfolio manager Nicolò Bragazza.
"The Bank of England can decide to not cut interest rates for two main reasons: inflation is higher than expected or growth is stronger than expected."
There is a contrarian argument, though: that the Bank is already being too cautious, and that its priorities should – despite its neutrality – be more aligned with concerns around economic growth.
"The Bank of England is taking a cautious approach," continues Field.
"At 5%, the UK has the highest interest rate of any major western economy, giving [it] wiggle room in terms of further rate cuts.
"Granted, the Bank wants time to monitor the effects of the interest rate cut made last month. But with inflation just hovering above the Bank's targeted level, the focus should really be shifting to reviving the UK's struggling economy, rather than worrying about the unlikely event of overheating."
And the UK is not the centre of the universe. Over in the US, tech stocks have been volatile since the early August selloff and since rebounded. Now the focus is on the Federal Reserve, which also meets this week, and whether it will make a 25 or 50 basis point cut. Markets are leaning toward the Fed going for the former, followed by additional decreases throughout the rest of the year and into 2025, says Morningstar.com markets reporter Sarah Hansen.
"The signals the central bank sends when it announces its decision Wednesday afternoon could shape how markets move in the coming weeks and months," she adds.
How Will Equity and Bond Markets Respond to The Bank of England's Decision?
But that is the theory. The practice remains to be seen. We've looked in detail at what it might mean for UK bond markets in After the Rate Cut, Should I Still Buy Bonds for Income?
Bragazza says the effect of the BoE's decision on asset classes will be as much a result of the way it is communicated, as it is the actual substance of the decision itself.
"Asset classes might have different reactions based on the reason why the BoE does not cut rates," he says.
"A rosier growth outlook could be well received by smaller-cap equities and equities in more cyclical sectors with more depressed valuations, especially in the UK, even after taking in account the higher funding costs which smaller companies are more sensitive to.
"On the other side, higher perceived risk on the inflation front is generally bad news for both equities and bonds. In addition to that, the ability of the BoE to clearly communicate the reason of not cutting rates is critical: a not-very-convincing argument may create uncertainty around the future path of the monetary policy, and this may have negative consequences on asset prices, especially for smaller companies and companies with higher valuations, which are generally more sensitive to changes in market sentiment.
"The impact on European assets of a BoE decision is difficult to assess, but it depends on how much the underlying reasons for keeping interest rates at the same level are common to European economies."
