As we expected, the Bank of England (BoE) held interest rates at 4% at November’s Monetary Policy Committee (MPC) meeting, although in a 5-4 vote. With inflation at almost double the target, the MPC’s waiting to see if the Autumn Budget is as disinflationary as the Chancellor hinted at in her Downing Street speech earlier this week. Assuming it is, we’ve pencilled in an interest rate cut for December. In any case, we expect the base rate to continue its downward path before settling around 3.5%.

Lower inflation peak coaxes MPC into ‘dovish hold’

The Bank of England opted for another hold in November, as we expected. The decision signals MPC members preferring to wait and see what the Autumn Budget has in store before deciding whether to make another cut this year.

The most interesting part of this month’s MPC meeting was the vote split, which was tighter than anticipated. Bank of England Governor, Andrew Bailey, used his casting vote to deliver a 5-4 majority in favour of a hold.

The vote split confirms our view that the MPC has moved in a dovish direction since the last meeting. Inflation now looks to have peaked and below the 4% it previously forecast. The latest MPC Summary and Minutes also states, “overall, the risks were now more balanced in regards to inflation”. This is a stark change from September’s Minutes when the Committee emphasised how “upside risks around medium-term inflationary pressures remain prominent in the Committee’s assessment of the outlook”.

What’s more, private sector pay growth has consistently surprised to the downside of the MPC’s forecasts recently. This will reassure the majority on the Committee of the retreating risk of the second-round effects outlined in the “inflation persistence” scenario. That’s where households’ and firms’ experience of nearly five years of above-target inflation prompt them to bargain more aggressively for pay rises and pass on price increases to consumers, which would keep inflation higher for longer.

November’s Minutes also confirm that Governor Bailey’s vote for a dovish hold was based on finding “the mechanisms underlying upside risks less convincing than those underlying the downside”. In other words, he’s more concerned about the risk of weaker demand from a persistently high savings ratio or, say, a contractionary Autumn Budget. Both would weigh on growth and allow inflation to fade quicker than in the BoE’s central forecast, suggesting interest rate cuts would be necessary.

Could we see another rate cut before the end of the year?

We agree with the MPC’s decision to hold interest rates. We also take the word “careful” being dropped from its guidance as further confirmation that interest rates will continue to come down over the coming months.

Indeed, a November rate cut had always seemed optimistic. The MPC is right to emphasise that the latest inflation figures are “just one month of data” and wait for a clearer signal. Compounding this, the bigger question over the coming weeks is whether the Autumn Budget will be disinflationary or stagflationary. The answer is likely to determine both how many and how quickly we’ll get future rate cuts.

However, we think a December rate cut is an odds-on bet for a few reasons.

First, inflation came in lower than expected in September and should now start to fall back. That said, some members of the MPC clearly wanted further confirmation. Fortunately, the Committee will have two more months of inflation and pay data to confirm this view by the next meeting, at which point they’ll likely be assured the disinflationary trend remains intact.

More importantly, the Chancellor seems intent on ensuring that the upcoming Budget avoids a repeat of last year’s where an array of stagflationary tax hikes pushed up inflation. A contractionary fiscal event that focuses on deflationary taxes – such as income tax – would leave the door open for the MPC to offset the negative effect on growth, potentially with both quicker and more rate cuts.

However, if the government opts to repeat last year’s smorgasbord of big increases to the smaller inflationary taxes to fill the hole in the UK’s public finances, then this would limit the MPC’s ability to cut interest rates to offset the negative effect on growth.

For now, we’ve pencilled in the next rate cut for December because we’re expecting a more deflationary budget than previously anticipated. Markets agree, almost doubling their bets on a December rate cut since Wednesday. In any case, we expect interest rates will continue to come down, reaching 3.5% by the middle of next year.

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