The Bank of England (BoE) was seen as a near certainty to cut interest rates in August, and the bank had previously hinted at doing so, but hopes of a cut in the summer were dashed by members of the BoE's interest rate setting committee.
Interest rates are being kept at a 16-year high of 5.25% to curb rising consumer prices, but rising rates are raising borrowing costs, including mortgages.
With inflation finally hitting the 2% target in May, markets had assumed a rate cut in the summer was all but certain.
Bank of England Governor Jonathan Haskell poured cold water on City forecasts, saying inflation is expected to return above the Bank of England's 2% target.
“We want to keep interest rates on hold until there is greater confidence that underlying inflation pressures have subsided sustainably,” Haskell, a member of the Bank of England's Monetary Policy Committee, said in a speech at King's College London on Monday.
Haskell is an outside member of the Monetary Policy Committee, whose term is set to end Aug. 31. Some members of the nine-member committee have argued in recent months for lowering official borrowing costs, but Haskell voted to keep rates steady.
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“As these shocks spread through the economy and labor markets remain tight and weakening, inflation is likely to remain above our target for a significant period of time,” Haskell said.
Bank of England Governor Andrew Bailey has previously stressed that inflation must be sustainably close to its target before the Bank of England takes action.
Basic wage growth remains at 6%, nearly double the rate that most policymakers consider consistent with 2% inflation. Services inflation also remained elevated at 5.7% in May, compared with core inflation at 3.5%. Core CPI has been declining more slowly than headline inflation, which is of concern.
Experts have warned that a rate cut this summer may be less likely until a majority of the MPC is convinced that inflation is under control.
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“The central bank will want to avoid a policy mistake where it cuts rates and then finds itself forced by forces beyond its control to postpone easing or, even worse, withdraw it altogether,” said Julian Howard, chief multi-asset investment strategist at GAM.
Globally, inflation is showing signs of resurgent, with the Federal Reserve postponing its interest rate cuts and the European Central Bank raising its inflation forecast for the rest of the year.
The Bank of England forecasts inflation to reach 2.5% by the end of 2024, and it sees price growth returning to a sustained 2% rate only in early 2026.
Another variable being discussed on Threadneedle Street is the new UK government's commitment to making the minimum wage a “true living wage”, following an almost 10% increase in the minimum wage floor in April.
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The party has pledged to fully implement its “New Platform for Workers” within the first 100 days.
“Labour's promise to introduce a 'real living wage' signals the possibility of faster wage growth and the risk of a slower pace of interest rate cuts, but the scale of change remains unclear,” said Goldman Sachs economists James Moberly and Sven-Jari Steen.
The Bank of England warned in June that April's increase in the national living wage “may have a bigger impact than expected”.
Ahead of its August meeting, the bank's MPC is due to publish new inflation data on July 17, followed by wages data the following day. The MPC will have a new member, Claire Lombardelli, replacing Ben Broadbent, who voted to keep rates on hold in June.
Despite the headwinds, investors now rate there a 60% chance that the Bank of England will cut interest rates to 5% when it next meets on Aug. 1. That would be the first cut since the pandemic began and provide relief to homeowners who have been hit by rising mortgage costs since the start of the year.
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Others are even more convinced, with money market traders betting £2 million that the Bank of England will cut interest rates by the most in four years next month.
According to Bloomberg, traders would make £8 million if policymakers cut borrowing costs by half a percentage point to 4.75% from 5.25% in August.
The last time the Bank of England cut interest rates by half a percentage point was days after the UK entered its first coronavirus lockdown in March 2020, when it reduced borrowing costs from 0.75% to 0.25%.
The Bank of England will announce its interest rate decision at around midday on 1 August, when it will also publish its Quarterly Monetary Policy Report and provide new forecasts, as well as hold a press conference in which Governor Bailey will speak for the first time since the general election.
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