Bond Watch: did the Bank of England signal an August rate cut?

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.               

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.                

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A big week for interest rates and inflation

The Bank of England decided to keep interest rates on hold, but signalled that it may cut rates in August – which is the next rate decision after a July break.

The Monetary Policy Committee (MPC) voted seven to two to maintain rates at 5.25%, with the two outliers opting to cut rates by 0.25 percentage points.

Inflation dropped to 2% in the year to May, below the 2.3% April reading. This is finally on target, which gives the central bank some breathing room to ease policy.

However, Michael Field, European market strategist at Morningstar, notes that much of the fall in inflation was driven by food prices. Core inflation, a measure that strips out volatile components, remains high at 3.5%. Core inflation excludes energy, food, alcohol and tobacco.

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“Underlying components here, such as services costs and home ownership costs, are unlikely to fall away anytime soon,” he said.

Therefore the Bank of England has not declared victory over inflation yet. In its notes for this week’s rate decision, the MPC said that monetary policy would need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term.

Nevertheless, analysts now say that a rate cut in August is possible. Gurpreet Garewal, macro strategist for global fixed income at Goldman Sachs Asset Management, says: “We anticipate the Bank is on course to initiate rate cuts in August, aligning with the easing actions of four other G10 central banks.

“Various members considered today’s decision to be ‘finely balanced’ between maintaining the current rate and implementing a rate cut, signalling an increasing inclination towards a shift in monetary policy towards easing.”

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The Bank of England itself even mentioned that August would be a key rate decision.

It said that as part of the August forecast round, members of the MPC would “consider all of the information available” and “keep under review for how long Bank Rate should be maintained at its current level”.

In response to the Bank of England’s notes, yields fell on gilts. A 10-year gilt now yields around 4%, down from about 4.1% a week ago.