Olympians, the Bank of England and fine margins

The 2024 Paris Olympics has offered us a timely reminder of the fine margins that exist in sport. For evidence, look no further than GB swimmer Adam Peaty, who missed out on gold in the 100m breaststroke by a wafer-thin 0.02 seconds. And Britain’s women rowers who beat the Dutch in a photo-finish.

Now, attempting to draw parallels between Olympic athletes and Bank of England’s nine-person Monetary Policy Committee (MPC) might be tenuous, but here goes.

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Earlier today it was announced that the MPC decided to cut UK interest rates for the first time in four years. But only by a whisker.

The decision couldn’t have been any tighter. Rumours in the lead up suggested it was too close to call, and that’s how it panned out. Like Peaty, it could’ve gone either way.

Rate setters voted by a majority of 5-4 to drop the Bank Rate 0.25 percentage points to 5%, after keeping it hold for the past 12 months.

In the MPC’s meeting minutes, even those who voted to cut admitted the outcome was on a knife edge.

“For some of these members, the decision was finely balanced. Inflationary persistence had not yet conclusively dissipated, and there remained some upside risks to the outlook,” the meeting notes said.

New phase, but caution urged…

Today’s outcome was a stark reversal from the MPC’s 7-2 split in favour of keeping rates on hold at its June meeting, and signals a new phase for policymakers’ strategy on monetary policy.

Improving data on two of the main obstacles for rate cuts may have influenced today’s decision. Private sector earnings growth dropped to 5.6% in the three months to May, and services consumer price inflation, while still a bit sticky, reduced to 5.7% in June.

These trends will need to continue to persuade the Bank to reduce rates further in the months ahead. The race to beat inflation is not yet won.

In fairness to policymakers, they have kept their word on when the time would be ripe to wield the axe. At previous meetings this year, the MPC repeatedly stressed it needed to see evidence that inflation will hang around the 2% mark sustainably.

Price rises spiralled to a 40-year high two years ago, largely due to soaring energy, food and petrol prices, hurting the finances of UK households.

But since the back end of last year inflation has softened dramatically. The consumer prices index (CPI), the UK’s main measure of inflation, eased to the Bank’s 2% target in May and plateaued in June.

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However, despite the wave of promising data, the Bank urged caution on whether a series of cuts will follow, saying that it “recognised that the stance of monetary policy could remain restrictive even if Bank Rate were to be reduced from its current level”.

The Bank also said that “monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further”.

Commenting on today’s decision, Bank governor Andrew Bailey – one of the five who voted to reduce rates - said: “We need to make sure inflation stays low and be careful not to cut interest rates too quickly or by too much.”

In short, the longer inflation stays around the 2% mark, the higher probability of further Bank Rate reductions.

Inflation is expected to speed up again later this year, increasing to around 2.75% according to Bank forecasts, as energy price falls drop out of the annual comparison.

For this reason, the next couple of interest rate decisions may be equally tight. The Bank has faced a delicate balancing act for some time, and this is set to persist, as policymakers walk the tightrope of helping to ease borrowing costs and keeping price rises under control.

Cost-of-living crisis starting to fade

A positive recent development for consumer finances can be found in the Bank’s recent Money and Credit statistics.

Households beefed up their savings by £8.4 billion in June, after ticking up £6.5 billion in May, providing further evidence that the cost-of-living crisis is ameliorating. Notably, an extra £3.4 billion was shovelled into individual savings accounts (ISA), a canny move by savers and investors, especially with Labour signalling tax rises are coming down the track.

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“The uptick in household savings is a step in the right direction and given the squeeze on the various tax allowances and thresholds, it is unsurprising more people are turning to ISAs for their tax efficiency,” said Nick Winter, financial planner at Quilter.

On an equally bright note, consumer credit borrowing nudged down from £1.5 billion in May to £1.2 billion in June. In addition, credit card borrowings fell to £0.5 billion in June, down from £0.6 billion in May.

“Given the hardships many have faced in recent years, it is encouraging to see the tides appear to be turning and more people are now able to put more money into savings and are becoming less reliant on borrowing,” Winter said.

What does this mean for investors and borrowers?

Most are familiar with the drill by now: when interest rates fall, so should borrowing and savings rates. To crowbar in another Olympics’ parallel, the two move in sync like Team GB divers and silver medallists Tom Daley and Noah Williams.

This means that you can borrow money more cheaply but get less interest on your savings. The main winners are borrowers on variable rates will see monthly repayments come down a bit, while those looking to secure a mortgage will have access to slighter better deals.

But what does the decision today mean for investors? Well, the interest rates paid on cash you hold within tax wrappers such as self-invested personal pensions (SIPP) and stocks and shares ISAs will likely fall a little over the coming days and weeks - as will Cash ISA rates.

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Although the impact here should be minimal, and for two reasons. First, investors typically keep only small cash holdings in SIPPs and ISAs, and allocate the bulk to assets geared up for higher growth, such as investments trusts, exchange-traded funds (ETFs) and funds.

And second, today’s cut is only minor. At 5%, the Bank Rate is still high relative to the past decade and a half. Savings rates will continue to significantly outpace inflation, which as noted above is currently just 2%, but by a slightly narrower margin.

With regards to your equity holdings, as falling interest rates tend to have a positive effect on share prices, your portfolio may benefit.

But otherwise, there isn’t too much action to take. Investing is a marathon not a sprint (sorry, I couldn’t resist one final reference to the Olympics), so the key is to stay wedded to the long-term plan.