That sound you’re hearing if you’re in the vicinity of the City of London, Canary Wharf, and especially Westminster, is a collective sigh of relief, one echoed by borrowers nationwide.
The Bank of England’s decision to cut interest rates by a quarter point to 4 per cent was widely expected. The smoke signals emanating from Threadneedle Street had suggested it was a done deal.
But as it turned out, the vote was on a knife edge: for the first time in its history, the nine-person rate-setting Monetary Policy Committee (MPC) was forced to take a second vote, with just five members backing a 0.25 per cent cut; four called for no change. The first vote went 4-4-1, with external member Alan Taylor – the first Rachel Reeves appointee – calling for a half-point cut.
Now, I support the decision to cut to 4 per cent. The economy is struggling. Unemployment is rising. Wage settlements are falling, a point those voting in favour of an interest rate cut took note of. But make no mistake, the decision still represents a big gamble on the part of the MPC.
Inflation is running hotter than expected. It came in at 3.6 per cent in June, and will likely show another rise when the July figure is in. The Bank has raised its expectations for the peak to 4 per cent in September. The MPC is fond of reminding us that its 2 per cent target applies “at all times”. Yet here it is, cutting when inflation is expected to double. This cut could have the effect of pouring petrol onto an inflationary fire.
It has clearly been made with the Bank’s secondary objective – supporting the government's economic policy, economic growth and jobs – in mind. You could make the case that it is a secondary objective cut. But the dissenters on the MPC – including chief economist Huw Pill and deputy governor for monetary policy (so interest rates) Clare Lombardelli – fear there’s trouble ahead.
They worry that what they call the “disinflationary process” in Britain has slowed, and inflation could once again dig in. I’ve made the point before: once this dragon finds a lair and gets itself established, it is very hard to get rid of. This helps to explain the sharp divergence of opinion on the MPC.
It is particularly interesting to see Bank governor Andrew Bailey among the cutters. Bailey is a cautious man, not given to risk-taking. He has kiboshed the idea of a digital pound when other countries are steaming ahead because of his nerves about the creation of a new type of money.
Backing a cut could yet prove to be a defining decision for him. If it works out, and inflation falls as expected from its September peak, and the economy starts to show a little life, we will have a lot to thank him for. But if he’s wrong, our living standards will decline as higher prices eat away at them. The Bank may even have to perform a volte face and increase rates down the line.
The MPC minutes correctly made note of the surge in food price inflation. It fears that this could “raise inflation expectations and generate greater inflation persistence” more widely. It hopes this won’t happen and things will start to improve in the new year. But food prices are ever volatile, hard to predict, and influenced by a wide range of external factors, not least the quality of harvests. In not unconnected news, British farmers experienced the driest spring in 70 years, and parching heatwaves this summer.
So, in effect, the MPC’s members are basically crossing their fingers in the hopes that it all comes good. This is not a happy place to be because the economy might not cooperate.
I wouldn’t expect a further cut for some time. Capital Economics is generally optimistic about the path for rates, and is sticking to its forecast of them declining to 3 per cent in 2026. But it had expected the vote to go 5-2-2, with two members calling for a 0.5 per cent cut.
“We’ve become a bit less confident in our forecast that the next 25bps rate cut will happen in November,” it said in a research note. No kidding. If there is another reduction to be had this year, I wouldn’t expect to see it until December.
But the cut is good news for holders of tracker mortgages. Their bills will fall. However, the nature of the vote and what the Bank’s minutes say could spell trouble for holders of fixed-rate mortgages, because the price of these isn’t directly linked to base rates. It is instead set by the City’s interest rate swaps market, which is driven by the longer-term outlook for rates. The Bank’s minutes would suggest a shallower, slower pathway from hereon out.
Nick Mendes, mortgage guru at broker John Charcol, says market momentum had been “pointing downward, helped by easing swap rates and increased competition among lenders”. However, the response of the swaps market to this decision may see that progress arrested.
Still, the Federation of Small Businesses says the cut “will be warmly welcomed”, and could encourage investment if lenders respond by offering its members lower rates. Here’s hoping that happens. But you’d rather not be relying on hope.
