Interest Rates – where do they go from here? 

Rob Evans, senior portfolio manager, Cash Investment, CCLA 

For the first time since the start of the pandemic, the Bank of England’s (BoE) Monetary Policy Committee (MPC) cut the Official Bank Rate (OBR) by 0.25%, ending the joint longest peak in rates since the BoE gained independence. 

In a notable first, the August meeting of the nine-member committee was the first time female members outnumbered their male counterparts – unique for any major global central bank.

Inflation proving more persistent than expected

Economic data since the MPC met in June 2024 has indicated that inflation is proving to be marginally more persistent than the Central Bank had expected.

Consumer Price Inflation (CPI) was in line with the BoE’s 2% target in June, but services inflation (currently the key component of inflation for the BoE) remained at 5.7% - considerably higher than where market and BoE forecasts had expected. 

However, another indicator closely followed by the BoE - pay growth in the private sector - dropped to 5.6% in the three months to May, leaving it broadly in line with the BoE’s expectations. Additionally, the jobs market looks to be slowing, with unemployment rates trending towards around 4.5% at its next reading, 0.2% higher than the bank’s May forecast.

Given the lack of communication from policymakers during the election period and the inconclusive nature of economic data, the considerable uncertainty preceding the MPC's decision was unsurprising.

The decision

The MPC’s conclusion was to cut OBR by the slenderest of margins, with five members in favour and four against. The committee pointed out that there had been “some progress” in curbing the persistence of inflation and it appeared to downgrade the importance of individual overshoots in services inflation data and above trend wage increases. 

The MPC said it expected this progress would lead to lower pay rises and would discourage firms from raising prices rapidly. However, there is a significant minority on the committee who did not share this view.

Governor Andrew Bailey was reluctant to declare victory in the fight against inflation, stating that they ‘need to make sure inflation stays low’ and that the BoE needs to ‘put the period of high inflation firmly behind us.’ Bailey also added that the UK economy had proven to be stronger in recent months – which brings the risk of higher inflation if rates are cut too much or too quickly.

Future path

Despite the cut in the OBR, the committee cautioned that monetary policy would need to continue to ‘remain restrictive’ for sufficiently long enough so that inflation is fully stamped out. This means that the BoE still views OBR at 5% as a constraint on economic output and over time there will be scope to lower rates further to support growth. That said, we think the reference to restrictive policy is a signal that any further rate reductions will be gradual.

The MPC offered no explicit guidance on the timing of subsequent rate reductions. 

When the MPC meets in November, it will be in possession of another round of economic forecasting and there will have been three more crucial CPI and labour market data releases. This will likely be the next opportunity for the BoE to enact another 0.25% reduction in OBR, especially as we suspect MPC will put less emphasis on the temporary, energy-price - driven pick up in CPI later this year. By that point the BoE will also have taken the autumn budget into account. 

Forecasting the trajectory of the OBR continues to be uncertain, particularly over extended horizons due to the potential impact of unforeseen geopolitical factors. That said, the MPC's latest inflation projections, which anticipate a decline to 1.7% and 1.5% in two and three years respectively, contingent on the market's projected OBR of 3.5% in three years, offer a potential framework for analysis.

We anticipate a gradual and measured reduction in the OBR over the next eighteen months, subject to the BoE's increasing confidence in the moderation of services inflation and wage growth.

Important information

This article is issued for information purposes only. It does not constitute the provision of financial, investment or other professional advice. Past performance is not a reliable indicator of future results. The value of investments and the income derived from them may fall as well as rise. Investors may not get back the amount originally invested and may lose money. Any forward-looking statements are based upon CCLA's current opinions, expectations and projections. Such opinions, expectations or projections may be subject to change at any time. CCLA undertakes no obligations to update or revise these. Actual results could differ materially from those anticipated.

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