Monetary Policy Committee preview: No move in June, August is the first chance of a rate cut

14 June 2024

The Monetary Policy Committee (MPC) will almost certainly keep interest rates on hold at its next meeting on Thursday 20 June. We also aren’t expecting any major changes in the committees forward guidance or the vote split. Financial markets are pricing in just a 5% chance of a rate cut next week and the committee will be loath to inject any volatility into markets so close to a general election. 

We expect the first rate cut to come in August, with that being followed by two more to leave interest rates at 4.5% by the end of the year. However, the risk is that the Bank chooses to start later and cut by less. 

In our view, a delay beyond August would be a mistake, even if the data comes in a little hotter than expected. Inflation is back at normal levels, the labour market is clearly loosening and GDP growth is still meagre. A gradual reduction in interest rates would support growth, without risk of reigniting inflation. 

Changing the rate of interest on reserves held at the central bank, as suggested by some political leaders over the weekend, is not a fundamentally barmy idea. It could save the Treasury a significant amount of money and encourage banks to lend more to the real economy. However, there are risks involved. Not paying interest on reserves is inherently a tax on banks that can cause distortionary behaviour and a sudden change in policy could disrupt the transition mechanism of monetary policy. Rather than scrapping payments on reserves altogether, gradually introducing a tiered system similar to the European Central Bank (ECB) would be a better and less risky reform. 

Three reasons why a June rate cut is dead on arrival 

First, the recent economic data has been mixed. Inflation didn’t fall quite as far as the MPC expected in April (2.3% vs 2.1%), although it probably fell back to 2% or 2.1% in May. Pay growth was also strong in April with private sector regular pay growth running at 5.8%, almost twice the 3% rate that the Bank of England (BoE) estimates is consistent with 2% inflation. 

Second, although the MPC is technically politically neutral and so it’s decision shouldn’t be affected by the timing of the election, it will be loath to introduce any potential volatility in financial markets so close to the election. Given that financial markets are pricing in just a 5% chance of a rate cut next week, it’s safe to say that such a decision would be a big surprise, causing a shock in financial markets. The strong wage growth data provides a convenient fig leaf to hide behind. 

Third, the economy appears to be picking up, despite high interest rates. A strong run of growth in the first quarter of this year, which saw Q1 GDP rising by 0.6% quarter-on-quarter, means the MPC may feel less need to cut rates to stimulate growth. 

It’s no surprise, then, that we expect the MPC to keep rates on hold next week. We also doubt that there will be a shift in the 7-2 hold-cut vote ratio, and in an effort to keep volatility down ahead of the election we doubt there will be any significant change in the forward guidance. 

Three reasons to rate cut in August 

While the June meeting might be dead, the August meeting is very much live and there are three good reasons why the MPC should follow the Bank of Canada and the ECB and start cutting interest rates. 

First, by the time of the August meeting inflation should be back at the 2% target. In addition, wage growth should have slowed markedly to around 5.5% and will be showing clear signs of a further slowdown in the second half of this year as the one-off impact of the near 10% hike in the national minimum wage recedes and the recent loosening in the labour market feeds through. As a result, by the late summer, it should be clear that the risks of a wage-price spiral have receded and that inflation will remain in the 2% plus or minus 1% band. 

Second, even though growth has picked up in Q1, the recovery is fragile. Growth flatlined in April, although some of this was weather related, and growth over this year is likely to be below 1%, not exactly the sign of an overheating economy. With inflation back at 2%, the collateral damage on growth of high interest rates becomes less necessary. 

Third, the MPC has made the point that interest rates don’t have to remain at 5.25% in order to be restrictive. The May MPC minutes reiterated the point that 'the restrictive stance of monetary policy is weighing on activity in the real economy, is leading to a looser labour market and is bearing down on inflationary pressures... monetary policy could remain restrictive even if Bank Rate were to be reduced'. This is more akin to the MPC slightly easing off the breaks, rather than pressing down on the accelerator. We view this guidance as a path to cuts unless there are big upside surprises.

Even so a rate cut in August is far from guaranteed. A large proportion of the MPC are clearly nervous about the strength of wage growth and services inflation. If inflation, wage growth or the GDP data comes in only slightly hotter than expected over the next few months, then this could be enough to prompt the MPC to delay cuts until September. 

In our view, a delay beyond August would be a mistake, even if the data comes in a little hotter than expected. Inflation is back at normal levels, the labour market is clearly loosening and GDP growth is still meagre. A gradual reduction in interest rates would support growth, without risk of reigniting inflation. 

Election a small risk to rate cuts

Whichever party wins the next election will face a difficult fiscal outlook. Current spending plans look hard to follow through on, but both main parties have ruled out large tax increases. To the extent that taxes are increased to fund further spending, the impact on inflation should be limited, requiring no intervention from the BoE. We currently expect interest rates to end 2025 between 3% and 3.5%. But further borrowing above expected levels could risk pushing up demand. This might cause interest rates to fall more slowly than that. 

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