Today’s decision by the Bank of England to cut interest rates from 4.25% to 4% has been broadly welcomed by investors, but differing views have been expressed on what it means and what happens next.
Jamie Niven, senior fixed income fund manager at Candriam, described the move as a “a surprisingly hawkish outcome from the Monetary Policy Committee (MPC).”
Indicating the problematic terrain the Bank of England (BoE) needs to navigate, Chris Arcari, head of capital markets at Hymans Robertson, said the central bank is being forced to walk the tightrope between weakening growth and persistently above-target inflation.
He points to monthly GDP data contractions in both April and May, while evidence that shows firms are cutting jobs in response to higher employer payroll taxes.
“This will intensify pressure on the bank to overlook the expected rise in inflation – forecast to reach nearly 4% in September and already above target,” said Arcari.
“The BoE is in an unenviable position: continue to cut rates and risk de-anchoring inflation expectations, regardless of whether the current price rise is temporary or not; or keep policy rates higher and risk delaying a revival in growth,” he added.
Looking at the governor’s approach, Andy Burgess, deputy head of investment at Insight Investment, noted a hawkish tone. “Given the stickiness of inflation, governor Andrew Bailey’s tone was more hawkish than markets anticipated and attempted to moderate expectations of anything other than a cautious path of rate cuts ahead,” he said.
Gilt yields nudged higher in the aftermath of the announcement.
Little impact
But Toni Meadows, head of Investment at BRI Wealth Management, said the rate reduction will have very little market impact.
“We are not expecting much of an impact on markets. In the days before the decision, sterling had already weakened a touch against the US dollar and interest-rate sensitive stocks already reflect the direction of travel on rates that began to be cut last August from a post-Covid peak of 5.25%,” he said.
And Meadows added that with the European Central Bank is likely to hold rates at current levels and with the timing of rate cuts in the US cuts uncertain, he does not think that UK rates can move more in the short term and the MPC will adopt a wait-and-see policy from this point.
“The narrow vote of 5-4 highlights the fact that the decision was contested, no doubt influenced by inflation rates that remain above target and wage growth running at levels which need to be curbed,” he said.
In fact, it is here that some disagreement emerges about what comes next.
Oliver Jones, head of allocation at Rathbones, said: “We expect the Bank of England to keep cutting interest rates once a quarter into next year.”
Jones noted that it is clear that the UK labour market is weakening, with jobs vacancies generally below pre-pandemic levels and numbers of employees clearly falling.
“For these reasons we expect the bank to keep loosening rates, despite inflation well above 3%,” Jones said. “The biggest risk to this would be any evidence that inflation will not fall back as fast as expected next year.”
Changes in government policy like higher national insurance and wage increases have kept services inflation in the 4.5-5.5% range for months. “But further increases, and food inflation running at 5% are also headaches for the MPC,” said Jones.
And Jamie Niven noted there is “a suggestion that additional disinflation is required for further cuts, raising the bar for more aggressive easing.”
He then added: “Ultimately, disinflation will come with the feedthrough from a weakening labour market and a slowing US, and therefore global, economy resulting in the Bank of England cutting more than the market currently prices.”
But Michael Metcalfe, head of macro strategy at State Street Markets, presents a different narrative about next moves. “With four dissenters, the future descent of UK interest rates remains in doubt,” he said. “With online prices still pointing to an acceleration of annual inflation through August, the MPC’s doubters look unlikely to be assuaged any time soon unless fiscal policy gets notably more contractionary.”
Zsolt Kohalmi, global head of real estate and co-CEO of Pictet Alternative Advisors, said more cuts are needed.
“To attract international investors and spur a genuine revival in UK commercial property, more cuts will be needed to restore the positive leverage dynamics and sharper asset valuations that tend to drive capital back into the UK real estate market,” he said.
And given the stare of play, Peter Goves, head of developed market debt sovereign research of MFS Investment Management, said he does not share the consensus opinion that gilts require a bearish reassessment of the economic or rate outlook.
“We continue to see value in gilts at prevailing yields, particularly on the short end,” he said. “It is also challenging to anticipate a significant consumer-driven rebound in economic growth in the near term.”
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