Why latest Bank of England rate decision is so significant

Few will be surprised by the Bank of England’s decision today to keep interest rates unchanged for the sixth consecutive meeting.

Bank governor Andrew Bailey has repeatedly stressed that policymakers want to see more evidence that inflation is under control. And despite falling sharply since autumn 2023, prices are still rising faster than the Bank’s 2% target.

• Invest with ii: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

However, the Bank has offered its strongest signal yet that policymakers are gradually warming to the idea of rate cuts.

The Monetary Policy Committee (MPC) voted by a majority of 7-2 to keep the Bank Rate at 5.25%, a 16-year high. Two members preferred a 0.25 percentage points reduction to 5%.

This is a significant development. In its meeting on 31 January, two members of the MPC voted for a 0.25% rise, while in March only one member preferred a cut.

The easing cost of living explains this change in stance. While UK inflation came in slightly hotter than expected in March at 3.2%, the direction of travel offers encouragement. A sharper drop is expected once April’s figures are revealed next week.

In its notes today, the Bank said it expects inflation will cool to its 2% target in the near term but tick up to around 2.5% in the second half of the year, “owing to the unwinding of energy-related base effects”.

The Bank did sound a note of caution, stressing “there continue to be upside risks to the near-term inflation outlook from geopolitical factors, although developments in the Middle East have had a limited impact on oil prices so far”.

Elsewhere, there was also some positive news for the UK economy, with GDP expected to have grown 0.4% in Q1 and set to rise 0.2% in Q2. If this comes to pass, it will lift the UK out of what will have been a very short recession.

And on the eve of today’s interest rate decision, the FTSE 100 continued its recent streak, closing at 8,354 points, a fresh all-time high. The UK’s main market climbed even higher at the time of writing, spiking to 8,394 just after today’s announcement at noon.

Where does this leave potential rate cuts?

Noises from policymakers suggest that rate cuts are now on the table at every meeting. In today’s media conference Bailey said: “A change in bank rates in June is neither ruled out nor a fait accompli.”

That said, rate cut expectations for 2024 have been pared back in the past few days. Markets are now pricing in two rather than three reductions this year.

The Bank’s guarded approach to monetary policy was recently supported by the Organisation for Economic Co-operation and Development (OECD).

In its 2024 Economic Outlook, the OECD said. “The fiscal and monetary policy mix is adequately restrictive and should remain so until inflation returns durably to target. Fiscal policy should remain prudent and focus on productivity-enhancing public investment when the monetary stance normalises.”

Economists, experts, and commentators are divided on when the Bank should wield the axe. Ahead of today’s decision, some urged rates to be cut immediately, while others felt it’s still a bit too soon.

• Sign up to our free newsletter for share, fund and trust ideas, and the latest news and analysis
• Making the most of your tax breaks in 2024

Regardless of what happens to inflation over the coming weeks, a seventh successive rate hold in June still appears the most likely outcome.

Financial markets reckon that the rate-cutting cycle is unlikely to kick off before August or September, with the Bank giving itself more time to monitor inflation’s trajectory.

A sticking point is the UK’s steadily improving economy. According to accounting consultancy EY: “While the UK’s economic outlook is expected to remain modest this year, growth is predicted to build throughout 2024 before accelerating in 2025 thanks to falling inflation, higher consumer spending and anticipated reductions in interest rates.”

Rate setters may fear that lower interest rates could increase consumer spending and subsequently spike inflation. However, one factor that may help to accelerate the arrival of rate cuts is easing pay growth. Annual private sector wage growth eased to 6.0% in the three months to February from 6.1% the time before.

Fed dilemma persists

The US Federal Reserve (pictured below) maintained interest rates last week in a target range of 5.25% to 5.5%, as widely expected. Inflation across the Atlantic is proving tougher to budge than in the UK, with less optimism about when rates will be cut.

In what previously seemed inconceivable, the options market now reckons there’s a 20% chance the Fed might hike rates in the next 12 months, according to the Financial Times.

This, however, remains an outside bet. US inflation is stagnant rather than hot. Although it does underscore the uncertainty surrounding future rate cuts.

In response to leaving rates unchanged for the sixth straight time, the Committee said it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%”.

The Committee noted the lack of progress in its bid to curb price rises – quite the contrary, in fact. US inflation has sped up in the past two months. The Fed hopes this undesirable trend will reverse when April’s CPI figures are revealed next week.

Europe out the blocks on rate cuts

Much of the recent talk has centred on whether the Bank will cut rates before the Fed - a previously unlikely prospect.

Some European central banks have decided not to follow the Fed’s lead. Earlier this week, Sweden became only the second major economy to cut interest rates.

On Tuesday, the Riksbank reduced its policy rate from 4% to 3.75% and indicated that two more cuts will arrive in the second half of the year – provided that inflation remains tame.

Inflation in Sweden recently eased to 2.2%, coming in softer than expected, and the nation’s growth outlook is currently weak. The Riksbank said that the combination of these two factors lends itself to looser monetary policy.

• How to build a £1 million pension and ISA portfolio
• The cost of not knowing your portfolio fees

In March, Switzerland became the first major central bank to cut interest rates since the global inflation problem began. In a surprise move, the Swiss National Bank (SNB) chopped rates from 1.75% to 1.5%, despite economists predicting things would stay unchanged.

Laying out its reasoning, the SNB said: “The easing of monetary policy has been made possible because the fight against inflation over the past two and a half years has been effective. For some months now, inflation has been back below 2% and thus in the range the SNB equates with price stability. According to the new forecast, inflation is also likely to remain in this range over the next few years.”

We should note that inflation in Switzerland is just 1.1% and has eased significantly from the 2.7% recorded a year ago.

Borrowers on tenterhooks

The situation in Sweden draws some parallels with the UK, notably that many of its residents are also struggling with 15-year high mortgage payments.

According to the latest Bank of England figures, in Q4 2023 the value of outstanding mortgage balances with arrears increased by 9.2% from the previous quarter, to £20.3 billion. Perhaps more worryingly, this was 50% higher than a year earlier, sparking fears of repossessions.

The average house price rose just 0.1% in April and has increased just 1.1% in the past 12 months. Once you factor in inflation, this represents a real terms fall.

EY predicts house prices will grow by 1.3% this year and tick up by a further 2% in 2025.

• Six steps to manage your own wealth
• Pensions case study: the final yards to retirement and beyond

With fewer rate cuts now expected in 2024, mortgage deals have started to become less favourable.

Amanda Bryden, head of mortgages, Halifax, said that affordability constraints are still a significant challenge for both new buyers and those rolling off fixed-term deals.

“Mortgage rates have edged up again in recent weeks, primarily as a result of expectations around future Bank of England base rate changes, with markets now pricing in a slower pace of cuts.

Bryden added: “If, as is still expected, downward moves in Bank Rate come into play later this year, fixed mortgage rates should fall. Combined with the resilience displayed by the housing market over recent months, we now expect property prices to rise modestly over the course of 2024.”