The Bank of England took the plunge at its August meeting and cut rates 25 bps—its first rate cut since 2008—taking Bank Rate to 5.00%. This was a finely balanced decision, mirroring market expectations going into the meeting. With inflation at 2% and signs that inflationary pressures are easing further out on the horizon, the Monetary Policy Committee (MPC) appears more confident that a reduction in the degree of restrictiveness is now warranted. That said, inflation is expected to increase close to 3% later this year, and other indicators of domestic inflationary pressure remain high, suggesting a series of aggressive rate reductions are off the table.
Our Take on the Meeting
As we have seen with other major central banks, the BoE has become more confident that the UK inflationary pressures are easing (see our take on the latest Fed meeting here). Indeed, monthly inflation is currently at the 2% target, and other measures, such as inflation expectations, wage pressures, and firm pricing decisions, have all declined, paving the way for today's cut.1
That said, we see this as an adjustment to the peak rate and not the start of an aggressive hiking cycle. The UK economy has demonstrated more resiliency, at the margin, than prior expectations, and inflation is projected to increase closer to 3% over the remainder of this year. That temporary rise comes at an awkward time, just ahead of the wage setting period concentrated in the months of January to April. Given that services inflation remains too high, we believe that this additional risk will curb the MPC's enthusiasm for more cuts (Fig. 1; see our take on the Bank of Japan's recent rate hike here).
Going forward, we expect the September meeting will be reserved for detailing the Bank's quantitative tightening plans over the following 12 months. Thereafter, we see the potential for a further rate cut in November, assuming no fiscal bazookas are announced on the October budget. That would leave Bank Rate at 4.75% by year end—lower, but still firmly in restrictive territory.
Market Reaction
Following the BoE's cut, the Gilts market bull steepened slightly, led by the 2-year Gilt yield falling more than 10 bps to 3.72%, its lowest level in more than a year. Sterling vs. the dollar dropped less than half a percent on the decision, which is in line with recent market volatility.
Considering the crosscurrents surrounding today's rate cut, we see reasons to be cautious of gilt valuations going forward. The Bank of England faces an uncomfortable paradox of deciding to cut Bank Rate while simultaneously increasing their expectations of near-term inflation to about 2.75% in the second half of the year.
The relatively muted reaction on behalf of regional markets found a subsequent tailwind as weak incoming data in the U.S. seemingly solidified the prospects for a September rate cut by the Fed.
Source(s) of data (unless otherwise noted): PGIM Fixed Income, as of August 1, 2024.
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