The Bank of England voted to cut interest rates for the first time since March 2020 in a knife-edge decision.
Five members of the Monetary Policy Committee (MPC), including Governor Andrew Bailey, voted to reduce the Bank Rate by 25 basis points while four, including chief economist Huw Pill, backed another hold.
The decision means interest rates now stand at 5.0 per cent, having stood at 5.25 per cent since last August. That was the joint longest period that rates have been left on hold since the Bank gained independence in 1997.
“Inflationary pressures have eased enough that we’ve been able to cut interest rates today,” Bailey said.
“Ensuring low and stable inflation is the best thing we can do to support economic growth and the prosperity of the country,” he added.
Investors were genuinely uncertain about what the Bank would decide today given the different signals on inflation over the past few months.
Inflation has been at the two per cent target for the past two months, having come down from a peak of over 11 per cent back in Autumn 2022.
However, indicators of underlying inflation have come in ahead of the Bank’s forecasts over the past few months, raising fears that price pressures might be more persistent than feared.
Services inflation, which the Bank has identified as a good gauge of domestic price pressures, remained stuck at 5.7 per cent in June, comfortably ahead of the Bank’s May forecasts.
Annual wage growth has also been running at 5.7 per cent, nearly twice the level consistent with inflation remaining at the two per cent target.
And even though rates have been held steady since last August, economic growth has actually accelerated in a sign that the economy is withstanding the pressure from tight monetary policy.
But, looking to the months ahead, members in favour of a cut saw enough evidence to suggest that inflationary pressures are slowly dissipating.
For the majority, the strength in services inflation reflected “more volatile” components rather than ingrained price pressures. The Bank’s own Decision Maker Panel suggests that wage and price pressures will continue to wane in future.
Despite the cut to Bank Rate, monetary policy will remain in restrictive territory which means it will bear down on demand. If demand remains weak, then firms may struggle to hike prices without losing customers.
“Domestic inflationary persistence is expected to fade away over the next few years, owing to the restrictive stance of monetary policy,” the statement said.
Still, the decision was “finely balanced” for some of these members, reflecting the continued upside risks to inflation.
The four members who voted to hold rates were wary that underlying inflationary pressures were “more entrenched”. They wanted to wait for further evidence before cutting rates.
The Bank gave no guidance on the future path of rates and Bailey stressed that the Bank must be careful “not to cut interest rates too quickly or by too much”.
Alongside the interest rate decision, the Bank published its latest economic forecasts which showed inflation picking up to around 2.7 per cent by the end of the year.
The increase in inflation will come about as last year’s steep drop in energy prices falls out of the annual comparison. This will reveal the “prevailing persistence of domestic inflationary pressures”.
It will then return to the two per cent by the start of 2026 and will remain below target for the remainder of the forecast period.
The Bank of England’s decision follows the Fed’s rate call last night. The US central bank opted to leave rates on hold for an eighth straight meeting, but signalled that a September cut is a real possibility.
The European Central Bank (ECB) has already started cutting interest rates, although yesterday’s upside surprise on inflation may slow the pace of subsequent rate cuts.