UK interest rate outlook: will Bank of England cut first?

Relief for stock markets that US interest rate cuts have been delayed rather than cancelled has been accompanied by optimism that the Bank of England could act as soon as June.

Last night’s Federal Reserve decision marked the sixth consecutive time the central bank has paused since starting its 5.25% cycle of interest rate hikes in March 2022.

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While US inflation did not come down as quickly as expected in the first quarter, Federal Reserve chief Jerome Powell said it was unlikely the next move on rates will be a hike.

The apparently high bar for further tightening of monetary policy gave the S&P 500 index an initial lift before shares fell back prior to the closing bell.

UBS Global Wealth Management said today its base case remains that inflation and economic growth will cool off, allowing the Fed to begin cutting rates in September.

It added: “In our view, current economic conditions are consistent with a soft landing this year, even if this outcome isn’t without an occasional speed bump, as has occurred in April.”

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The bank expects further modest gains for equities at the index level and forecasts the S&P 500 index to end the year at 5,200 compared with today’s opening position of 5,018.

UBS added: “This supports our most preferred view on quality stocks and fixed income and our focus on finding equity opportunities both within and beyond the technology sector.”

America’s best-known banker, JPMorgan Chase boss Jamie Dimon, told shareholders last month that inflation could prove to be more persistent than expected.

His bank is prepared for a very broad range of interest rates, from 2% to 8% or even more, with equally wide-ranging economic outcomes. Dimon highlighted the fuel in the US economy of large amounts of government deficit spending and past stimulus.

The “higher for longer” rates outlook in the United States has highlighted the potential of a divergence with the UK and Europe, potentially weakening the pound against the dollar.

UK economists are focused on the possibility that the Bank of England monetary policy committee (MPC) could act first, although not at next Thursday’s rates meeting.

Deutsche Bank economist Sanjay Raja said today: “We expect the MPC to keep the Bank Rate on hold at 5.25% for a sixth consecutive meeting. But this doesn't mean that the May meeting will be uneventful. We expect the MPC to set the stage for a June rate cut.”

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He expects more than one policymaker to vote for a cut in May, with the MPC's projections also set to show a faster descent to inflation’s 2% target alongside a dovish tilt to forward guidance.

Since its February projections, the Bank has seen economic activity improve, inflation move broadly in line with forecasts and the labour market show signs of loosening.

Raja added: “We continue to expect a total of 75 basis points of rate cuts this year (Jun, Sep, Dec). Where Bank Rate goes next year, however, is becoming increasingly uncertain.”

At February’s meeting, the Bank said it had shifted from thinking about whether to raise rates to when to cut rates. A month later, governor Andrew Bailey said “we are not yet at the point where we can cut rates, but things are moving in the right direction”.

Capital Economics said today that the first rate cut is more likely to come in August if the Bank fails to use next week’s May meeting to signal that a rate cut is close.

By then the Bank will have had three sets of inflation and labour market releases from which to confirm that inflation is becoming less persistent.

The consultancy expects CPI inflation, services inflation and wage growth to all fall faster and further than the Bank thinks, potentially forcing policymakers to change their stance by June.