BoE Holds Rates at 5% Amid Sticky Inflation

"Since the MPC's previous meeting, global activity growth has continued at a steady pace, although some data outturns suggest greater uncertainty around the near-term outlook," the Bank said.

"Oil prices have fallen back, reflecting in large part weaker demand. Market-implied paths for policy rates across major advanced economies have declined.

"In the absence of material developments, a gradual approach to removing policy restraint remains appropriate. 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"—words investors are already well used to hearing.

Michael Field, European market strategist at Morningstar, argues the BoE is probably waiting to see the effects of its original August cut.

"[This decision] makes sense in that they only cut last month, and if you look at what the central banks globally have been doing—from the Federal Reserve to the ECB—the idea is to cut, then to wait a month or two to see how the data reveals itself," he says.

"[Then the BoE will] see if there have been any major ramifications from the cut and then cut again. That seems like the modus operandi for the central banks. That is why a lot of economists thought it would not happen."

Why Did the Bank of England Hold Rates?

This week the UK's Office for National Statistics found that the UK's service sector faced significant price pressures in August, with services inflation rising to 5.6% because of summertime demand for airline tickets. That means inflation is still persistent in some areas.

The BoE has also been managing expectations about the situation for a long time. At the end of August, BoE governor Andrew Bailey said he was "cautiously optimistic" about inflation, but added it was too early to "declare victory" against continued higher prices.

"Recent experience leads me to be cautiously optimistic that inflation expectations are better anchored as a result of the regimes we have in place," Bailey said in a speech at the Jackson Hole summit of central bankers.  

 "The second-round inflation effects appear to be smaller than we expected. But it is too early to declare victory," he added.

That comes in stark contrast to sentiment in the U.S., where yesterday's 50 basis points rate cut all but confirmed the Federal Reserve's view that the lion's share of the battle against inflation is over.

When Will The Bank of England Cut Rates?

A rate cut would have delighted equity markets, so it is unsurprising that the BoE's rate hold was met with a small dip on the FTSE 100.

At 11:55am, the UK's blue-chip index was trading at 8,370 points—it then fell to 8,328 after the midday announcement, before stabilising at 8,333, 1% higher than Wednesday's close.

Markets continue to anticipate the likelihood of a UK rate cut, with all eyes now on November. Further rate cuts are also expected in 2025.

"Markets seem to be pricing in one more rate cut, which is likely to come later in the year," Field said two weeks ago.

Today, equity managers are also uncowed. Andrew Jones, portfolio manager at Janus Henderson's equity income team, is still expecting a rate cut later this year.

"With two months more of economic data to consider by the time of the next meeting, we believe the UK rate will be lowered again in November and [we] expect further cuts in 2025," he says.

Candriam senior portfolio manager Jamie Niven agrees.

"We think it's very likely we'll see another 25 basis point cut in November and possibly again in December, but our biggest conviction is the terminal rate of the cutting cycle, which we continue to believe should be lower, especially relative to what's priced for the US and Euro terminal rates," he says.

How Did The Gilt Markets React?

UK government bond prices barely moved in response to the BoE's "no change" decision, with only a couple of basis points added to maturities from two years to 30. Gilt yields have already moved this year in anticipation of monetary easing from the Bank, with two-year gilts yielding just below 4%, compared with just below 5% last year.

What's notable, however, is the two-year gilt yield has actually increased by around 20 basis points in the last month, which suggest bond markets are adjusting their assumptions to the speed of the BoE's rate-cutting trajectory. Inflation is close to target but policymakers are wary of cutting too quickly, especially with core inflation actually rising month on month.

Watchers of UK government bond markets will also note that the Bank will continue selling its stock of gilts, reversing the quantitative easing period incrementally. Recall that the Bank has been a buyer of gilts since the financial crisis. The Bank will shed a further £100 billion of government debt over the next 12 months, in 2024-2025, to £558 billion. There's more on what the supply and demand of gilts will mean for prices and yields in a recent article, After the Rate Cut, Should I Still Buy Bonds for Income?

Candriam's Niven argues that this £100 billion was "positive versus expectations" and  "could help to support the longer end of the gilt curve".

The BoE's press conference on Aug. 2, which accompanied the first rate cut since the pandemic, suggested the central bank is not in a hurry to cut rates. This aligns the BoE with the European Central Bank, which has favored a "cut and wait" approach that depends on economic data, which can be volatile and send mixed messages.

Markets now expect the next rate cut to be on November 7, after the first Labour Budget on October 30, when the Bank's latest monetary policy report will also be published.

Assuming no change to rates on December 19, a November cut then would leave interest rates at 4.75% by the end of the year, much higher than the forecasts by financial markets and economists at the start of 2024.

We are updating this story as more information becomes available. With additional reporting by James Gard and Ollie Smith