Last week’s Bank of England decision to cut the base rate to 4.25% was highly anticipated by markets, so will hardly come as a surprise. What is interesting is what it potentially reveals to investors.
Despite the bank cutting the policy rate by 25bps as expected, the decision was not clear-cut, coming in a split 2-5-2 vote, with two members voting for a hold and two members voting for a 50bp cut.
“What is surprising is the balance of votes on the Monetary Policy Committee (MPC) with two voting for a bigger cut and two voting to hold,” said Derrick Dunne, CEO of boutique You Asset Management.
Dunne’s point being that the group that makes the decision, the MPC, is looking “through” the inflation figures – with potential bigger cuts on the way.
“The two members who voted for a 0.5% cut perhaps point us in the most important problem the bank now has – are rates set too high for an economy under major pressure?” he said. “The fact is we’re seeing inflation still forecast somewhat above target this year – and yet we have seven members who want cuts.
“Whether we get more aggressive cuts remains to be seen,” he added.
“The MPC has demonstrated its willingness to see through the inflation figures and act on economic trouble. Whether that trouble now worsens will dictate how much faster rate cutting gets for the rest of this year,” Dunne said.
This comes against a backdrop of the UK signing important trade deals with major international trade partners – something that should encourage markets the UK still has some signs of promise.
“Whether those deals amount to mitigating problems, rather than opening new opportunities, remains to be seen,” Dunne said.
Lauren Ledger-Evans, assistant portfolio manager for Ninety One’s global income team, said the decision had hawkish overtones. “Overall, it was a more hawkish outcome than market expectations in terms of both the vote split and the forward guidance, raising the bar for sequential [back-to-back] rate cuts from the bank in the near-term,” she said.
Overall, Ledger-Evans said she maintains the view that the bank will continue to cut the policy rate down to an estimated nominal neutral rate of 3% to 3.25%. “But acknowledge that the more-hawkish-than-expected reaction function raises the bar to a faster pace than current market pricing,” she added.
Peder Beck-Friis, an economist at Pimco, also noted: “The Bank of England seems to be buying time, emphasising significant uncertainty around growth and inflation.”
“We see good reasons why the BoE will continue easing policy and even accelerate the pace in the second half of the year,” Beck-Friis added. “The starting level of the interest rate is high, well above our neutral range estimate of 2% to 3%.”
In addition, he also noted that with fiscal policy tight and global trade likely to weaken, Pimco expect increased pressure on monetary policy to act as the shock absorber, potentially even adopting a looser policy ahead.
Michael Metcalfe, head of macro strategy at State Street Markets, said the cut is about addressing risks. “The BoE’s cut is attempting to get ahead of the potential downside risks to growth, but with two MPC members dissenting and coming, as it does, at a time when hopes of a trade deal with the US are rising, any negative impact on sterling should be modest,” he said.
Meanwhile, the fact the committee was content to keep quantitative tightening at its current pace reinforces the message they are “unperturbed by the recent volatility in long-dated bond yields,” Metcalfe said.
Chris Arcari, head of capital markets at Hymans Robertson, said that UK inflation was still a concern for investors. “Average wage growth is still running at close to 6% year-on-year, inflation in the labour-intensive services sector is at 4.7% year-on-year, and core inflation, at 3.4%, remains well above the central bank’s 2% target,” he said.
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