The Bank of England’s monetary policy committee (MPC) was never going to cut interest rates today. Not two weeks before a general election.
Cutting the cost of borrowing would have been perceived as highly political, potentially offering support to the government, even though some Conservative politicians, such as the former business secretary Jacob Rees-Mogg, sought to argue ahead of today’s decision that not cutting Bank rate could equally be perceived as “a political decision against the government”.
So it was no surprise to see the MPC maintain Bank rate at 5.25% or, indeed, for the composition of the vote, at 7-2, to remain unchanged from last time around with uber-dove Swati Dhingra and Sir Dave Ramsden, again, outnumbered in voting for Bank rate to be cut to 5%.
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The MPC also went out of its way to show how it is finely attuned to criticisms of bias one way of the other.
The minutes note: “The committee noted that the timing of the general election on 4 July was not relevant to its decision at this meeting, which would as usual be made on the basis of what was judged necessary to achieve the 2% inflation target sustainably in the medium term.”
Leaving aside the politics, though, there were very good reasons why most of the MPC voted for no change today.
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Chief among these was the fact that, although the headline rate of consumer prices inflation in May returned to the Bank’s target rate of 2% for the first time since July 2021, services inflation remains uncomfortably high at 5.7%.
That will have raised alarm bells on the MPC about the risk of so-called ‘second round effects’ whereby firms and workers respond to higher prices by themselves seeking to raise their prices or their wages and not least because services make up four-fifths of the UK economy.
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The MPC minutes noted today that services inflation was “somewhat higher than projected” when the Bank published its most recent inflation report only last month.
The minutes added: “This strength in part reflected prices that are index-linked or regulated, which are typically changed only annually, and volatile components.”
The MPC is also very wary of the possibility that inflation is likely to begin creeping higher again later in the year. That is due to so-called ‘base effects’ – the year on year comparison – and the fact that, in the second half of last year, the price of some goods in the inflation basket were falling or, at least, not rising as rapidly as they are expected to in the second half of last year. A good example of that, which stood out in the inflation figures published on Wednesday, is unleaded petrol – a litre of which cost 144.4p in May last year but which cost 148.8p in May this year.
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And more broadly, the economy is growing more strongly than the Bank has been expecting, as are several indicators of economic activity, among them spending by households on repair and maintenance of their homes and consumer confidence.
The other major concern that the MPC continues to have is that wage inflation, at 6% during the three months to the end of April, remains too high for its liking.
The latest report from the Bank’s network of regional agents – whose briefings are closely studied by the MPC’s members – suggest that recruitment difficulties are “near to their pre-COVID levels” which represents “a historically high level”.
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Other survey data has also persuaded the MPC to conclude the labour market remains “a little tighter than official data” suggests.
The minutes highlight concerns that near-term pay growth may moderate by less than the Bank was expecting in its May report. Consumer-facing businesses, which are most exposed to the National Living Wage, in particular are having to pay more to employees.
That said, a reduction in Bank rate is coming, with the MPC noting: “The restrictive stance of monetary policy is weighing on activity in the real economy, is leading to a looser labour market and is bearing down on inflationary pressures. Key indicators of inflation persistence have continued to moderate, although they remain elevated.”
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The timing of that reduction is now going to be more fiercely debated than ever. Wednesday’s inflation data, with that unexpectedly strong reading for services inflation, pushed market expectations for the timing of that first cut out from August to September.
Today’s minutes, though, have persuaded some market participants to conclude that an August reduction in Bank Rate may be back on.
The key line in the minutes that have raised that prospect was that, among some MPC members who voted for no change this month, “the policy decision at this meeting was finely balanced”.
So the big takeaway from today’s minutes is that the door remains open to an August reduction in Bank rate. The market was putting the probability of an August rate cut at 30% prior to the meeting. It is now placing a 60% probability on that.
But an August rate cut is not nailed on – and politics may yet rear its head.
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The MPC will be watching, closely attuned to how markets react to the election result.
As Julian Howard, Chief Multi-Asset Investment Strategist at GAM Investments, put it: “A potential Labour landslide could unsettle markets, in particular the currency.
Sir Keir Starmer has come under pressure in recent days on the issue of tax and spending. Sterling will appreciate neither unfunded spending, nor a heavier tax burden.”
A weaker pound would, in turn, revive concerns about imported inflation.
And that would probably persuade the MPC’s members to maintain the cautious approach that they and their peers at the US Federal Reserve have this year for at least one more month.
