BoE surprises with an interest rate cut

The Bank of England finally delivered its first interest rate cut in the current cycle, showing the ‘doves’ on the Monetary Policy Committee (MPC) to be in the ascendancy. The key turning point in finally allowing rates to be cut appears to be the replacement of Ben Broadbent on the MPC by Clare Lombardelli, who in her first meeting showed herself to be a ‘dove’, voting to cut rates whereas Broadbent had been in the camp voting to keep rates on hold. And with economic data still leaning in favour of keeping monetary policy unchanged, the question arises as to whether interest rate policy in the UK is decided just as much by who is put on the MPC as by the data itself.

Nevertheless, the markets initially interpreted today’s decision as a ‘dovish’ signal by the BoE. Despite economic data suggesting policy should probably remain unchanged, the BoE issuing its usual warning that policy would need to remain restrictive for sufficiently long, and the BoE itself forecasting CPI to creep up to 2.7% by year-end, the interpretation of today's meeting is that the MPC is concerned that CPI may undershoot its target on a 2-year time horizon if monetary policy is not loosened. This has naturally raised expectations that the pace of easing going forward may be more rapid than had hitherto been expected. It also suggests the MPC’s tolerance for data misses is higher than might be expected, given that it chose to dismiss the strength being seen in services sector inflation and the stronger economic growth numbers being seen.

The modal inflation forecast given by the MPC today showed CPI at 1.7% in Q3 2026 and 1.5% in Q3 2027, if interest rates fell in line with the market expectations shown ahead of today’s meeting (4.87% in Q4 2024 and 4.09% in Q4 2025). Those CPI forecasts are 10bps lower than contained in the BoE’s May forecasts and suggest that the BoE is becoming increasingly confident that CPI will fall back to target despite the problems of persistent services sector inflation and stronger growth. And it is this expected undershoot that has persuaded enough members of the MPC to vote to cut rates today and for the markets to initially expect a faster pace of cuts going forward.

However, the real picture is probably somewhat different. Even though five members of the MPC voted to cut rates today, a number said the decision was “finely balanced.” And as noted above, if Broadbent had still been on the MPC, the likelihood is that rates would have been kept on hold today. In the press conference following the meeting, Governor Bailey has also been keen to dampen down any potential exuberance concerning further rate cuts that could bubble up from today's decision. Overall, it points to today’s cut being a ‘hawkish’ cut, implying that going forward any further loosening in policy is going to be gradual. The market appears to have taken this message on board, envisaging at most one cut per quarter going forward, and which is being reflected in sterling recovering most of the losses seen going into the meeting from last night, UK equities largely giving back the gains made immediately following today’s decision, and UK gilt yields arresting their post-meeting declines.

In conclusion, despite the surprise of today’s decision, going forward monetary policy is going to be loosened only gradually - the UK inflation genie is still not quite yet firmly back in its bottle.