As expected, the Bank of England (BoE) held interest rates at 4.25% at its meeting this month. The Monetary Policy Committee (MPC) kept its “gradual and careful” guidance unchanged, acknowledging that the labour market was weakening faster than expected and oil prices had surged 26% since May’s meeting. Prompted by recent weak data, three members voted in favour of a cut, compared to the two we expected. We still anticipate two more cuts this year, leaving interest rates at 3.75%.

MPC members are clearly split

The most interesting part of the decision was the 6-3 vote split. Three members, rather than the two we predicted, would’ve preferred another 25bps cut in June’s meeting. This suggests two things.

First, the labour market is causing dovish MPC members slightly more concern than before. The MPC minutes referenced a “material further loosening in the labour market”, weaker than expected pay growth and concerns that an unduly large output gap would open in the medium term. Translating that from central bank speech, there is clearly some worry that interest rates are too restrictive and that this could weaken the economy more than is necessary to return inflation to 2%.

Second, oil prices haven’t yet moved enough to convince the MPC to change tack. Oil prices have risen 26% since the May meeting. Yet the minutes stated that: “Recent global developments had not had a significant impact on this meeting’s policy decision”. That allowed the doves to focus on the weakening labour market.

Turning to the hawks, inflation is 3.4% and set to head higher over the summer. Wage growth is still too strong and members reiterated their concerns over inflation expectations becoming unanchored. The main worry was food inflation, which rose to 4.4% in May from 3.4%. That’s because food is particularly salient for households and more likely than other items to influence perceptions of inflation. What’s more, the MPC had upgraded its growth forecast in Q2 to 0.3% from 0.1%, suggesting the economy is slightly stronger than it had initially thought in May. That would also strengthen the case to focus on inflation.

Oil prices could push inflation above 4%

Looking ahead, the big risk is energy prices. We don’t think the recent rise in oil prices will change the MPC’s thinking. However, a shift towards $85 per barrel or higher would probably push inflation over 4%. That’s important for the MPC because the academic literature suggests that’s when households start bargaining for bigger pay rises to protect their real incomes.

Normally we’d expect the MPC to look through energy-driven inflation movements. This is because prices can be volatile and monetary policy can’t feed through into the economy quick enough to have a material effect. However, inflation expectations are currently far too high. A big rise in prices at the pump would push them higher and could prompt the MPC to slow the pace of easing.

The dovish data around the labour market in recent weeks and stalled growth clearly prompted some MPC members to lean into another interest rate cut. However, we think the risks are tilted towards just one more cut. If rising energy costs encourage households and firms to bargain for bigger pay rises and to hike costs, then the MPC may have to skip a cut to weigh on inflation. Ultimately, interest rates are still restrictive, giving the MPC room to cut rates. Our base case remains for two more cuts this year, which would leave interest rates at 3.75% by the end of the year.

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