Fading hopes for interest rate decrease following Bank of England's decision
city investors have reconsidered their projections for multiple interest rate reductions in the near future, following the Bank of England's decision to trim rates to 4.25% last Thursday. Previously, markets bet on around three more cuts this year, involving rates touching 3.5%, anticipating the Bank to lower borrowing costs further.
However, the Monetary Policy Committee's seemingly hawkish stance has prompted second thoughts among investors. Presently, traders are pricing in two more cuts this year, while a third cut's prospects stand at a 40% chance. In comparison, the chances of three more cuts following the May decision were approximately 80%.
This shift could be attributed to the discord within the MPC, as the split decision (5-4 in favor of a 25 basis point cut) showcased diverging opinions among rate-setters. Notably, external members Swati Dhingra and Alan Taylor advocated for 50 basis point cuts, while chief economist Huw Pill and Catherine Mann voted against any immediate cuts.
Deutsche Bank's Sanjay Raja described the split as a reflection of a more divided MPC. "The probability of sequential back-to-back rate cuts should drop on the back of this," he said. Goldman Sachs economist Sven Jari Stehn and James Moberly were among analysts who felt the Bank's decision to stick to its 'gradual and careful' approach to rate-cutting was surprising, particularly after the minutes were deemed more hawkish than expected.
In the minutes, members who backed the rate cut stated that they did so with different rationales. Interestingly, before the latest global news on a UK-US trade deal, most of the five members who voted for the 25 basis point cut regarded the May decision as 'finely balanced' between no change and a cut. However, for some members in that group, the case for a cut was 'fairly clear' even before the latest global developments. In contrast, those who voted to maintain the status quo appeared influenced by the declining short-end market interest rates since the March meeting.
The minutes also noted that two members advocated for larger cuts (50 basis points) due to concerns over an unduly large output gap and inflation deviating from the target on a sustained basis. Meanwhile, those who voted against further cuts argued that the continued policy stance could be too restrictive.
The minutes also acknowledged the double-edged risks posed by President Trump's tariffs, implying they would have a primarily disinflationary effect. Economist Ruth Gregory suggested that Bank Rate might drop as low as 3.75% by the end of the year, despite fewer expectations for additional rate cuts due to the divided MPC.
In summary, the UK's economic growth slowdown, subsiding inflation, external factors such as tariffs, and a less united MPC are all elements shaping the future direction of interest rates with uncertainty. Any further rate cuts would depend on how these elements evolve in the coming months.
- The shift in investment projections can be linked to the Monetary Policy Committee's divided stance on interest rate cuts, as displayed by the 5-4 vote last week, which has made sequential rate cuts less likely, according to Deutsche Bank's Sanjay Raja.
- Goldman Sachs economist Sven Jari Stehn and James Moberly, along with other analysts, found the Bank of England's decision to adhere to a 'gradual and careful' approach to rate-cutting surprising, particularly given the seemingly more hawkish minutes.
- The debate among rate-setters within the MPC is evident, with external members Swati Dhingra and Alan Taylor advocating for 50 basis point cuts, while chief economist Huw Pill and Catherine Mann voted against any immediate cuts.
- Economist Ruth Gregory predicts that Bank Rate may drop as low as 3.75% by the end of the year, despite the divided MPC suggesting fewer expectations for additional rate cuts due to the evolving elements of the UK's economy, inflation, external factors such as tariffs, and the economic growth slowdown.
