Bank of England holds rate but eyes cuts ahead despite global risks
The Bank of England has signalled that a weakening labour market could yet trump rising global challenges to allow for more interest rate cuts in the near term.
Policymakers on the nine-member monetary policy committee (MPC) voted 7-3 to maintain Bank rate at 4.25%.
There was greater support than was expected for a cut.
The Bank had previously signalled that a majority on the committee were cautious about the effects of global instability – especially the on-off US trade war.
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But the minutes of the Bank’s meeting showed there was a greater focus on a rising jobless rate and evidence that employers are shedding jobs – indicating it had dominated the meeting.
It acknowledged, however, that there were potential challenges from the on-off US trade war and as a result of the Israel-Iran conflict.
The barrage of warheads has already resulted in double-digit percentage spikes to oil and natural gas prices in the space of a week.
“Interest rates remain on a gradual downward path,” governor Andrew Bailey said while adding that there was no pre-set path.
“The world is highly unpredictable. In the UK we are seeing signs of softening in the labour market. We will be looking carefully at the extent to which those signs feed through to consumer price inflation,” he added.
The Bank maintained its core message that it would take a “gradual” and “careful” approach.
“Energy prices had risen owing to an escalation of the conflict in the Middle East. The committee would remain vigilant about these developments and their potential impact on the UK economy,” the Bank said.
The rise in the UK’s jobless rate, along with recent data on payrolled employment, has been linked to a business backlash against budget measures, which kicked in in April, that saw employer national insurance contributions and minimum pay demands rise.
While a weaker labour market, including a fall in vacancies, could allow room for the Bank to react through further interest rate cuts, the spectre of war in the Middle East is now clouding its rate judgements.
The last thing borrowers need is an inflation spike.
The UK’s core measure of inflation peaked above 11% in the wake of Russa’s invasion of Ukraine – giving birth to what became known as the cost of living crisis.
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Businesses facing fresh energy cost threat
Inflation across the economy was driven by unprecedented spikes in natural gas costs, which pushed up not only household energy bills to record levels but those for businesses too – with the cost of goods and services reflecting those extra costs.
Borrowing costs have eased, through interest rate cuts, as the pace of price growth has come down.
The rate of inflation currently stands at 3.4% but was already forecast to rise in the second half of the year before the aerial bombardments between Israel and Iran had begun.
LSEG data shortly after the Bank of England minutes were published showed that financial markets were expecting a quarter point cut at the Bank’s next meeting in August and at least one more by the year’s end.
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Commenting on the Bank’s remarks Nicholas Hyett, investment manager at Wealth Club, said: “Conflict in the Middle East risks higher energy prices potentially pushing inflation higher – though calling the course of events there is almost certainly a mugs game, and the Bank has said that under current conditions it expects inflation to remain broadly at current levels for the rest of the year.
“The risk is that all the uncertainty leaves the Bank paralysed, with rates stuck at their current level,” he concluded.
There is “considerably more doubt” over when future interest rate cuts can take place, the governor of the Bank of England has said.
Andrew Bailey told a committee of MPs that the risks around inflation had gone up and he was “more concerned” about weakness in the labour market.
Bank staff projections expect the main consumer prices index measure of inflation to rise to 4% this year – double the 2% target rate – from its current level of 3.8%. Food prices are proving the main driver currently, with part of the increases blamed on government tax rises on employers.
On the prospects for further interest rate reductions this year, Mr Bailey said: “There is now considerably more doubt about when and exactly how quickly we can make those further steps.”
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Interest rates are elevated to help ease the pace of price growth and cut, when able, to help maintain inflation at the 2% target level.
The governor was speaking after the Bank’s split vote last month that resulted in a quarter point reduction for Bank rate to 4%.
At that time, the governor said that while he still believed that the future path for borrowing costs was still downwards gradually over time, financial markets had since understood that the outlook for the pace of cuts was more murky.
“That’s the message I wanted to get across”, he told the Treasury select committee.
“Now, I think actually, judging by what’s happened, certainly to market pricing since then, I think that message has been understood.”
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A further quarter point cut to 3.75% is no longer fully priced in for this year, according to LSEG data on market expectations.
He was speaking as financial markets continued to see a widespread sell-off of long-dated bonds, largely over fears of rising government debt levels in many western economies including the US and UK.
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Why did UK debt just get more expensive?
The activity has taken the yield – the effective interest rate demanded by investors – in 30-year gilts to a 27-year high this week. Other shorter dated bonds have also risen sharply.
But Mr Bailey urged less of an emphasis on the long-term gilts, as headlines point out that any increase in the cost of servicing government debt is a headache chancellor Rachel Reeves can well do without as she battles to balance the books.
He told the MPs: “It’s important not to … over focus on the 30-year bond rate. Of course, it’s a number that gets quoted a lot, it’s quite a high number. It is actually not a number that is being used for funding at all at the moment.”
Mr Bailey also waded into the continuing row across the Atlantic that sees the independence of the US central bank, the Federal Reserve, threatened by Donald Trump and his quest for interest rate cuts.
He has moved to fire a Fed governor over alleged mortgage fraud and make a new appointment but Lisa Cook, who was appointed to the board by Joe Biden, is fighting his bid to oust her in the courts.
“This is a very serious situation”, Mr Bailey said.
“I am very concerned. The Federal Reserve… has built up a very strong reputation for independence and for its decision making,”, adding that trading central bank independence against other government decisions would be a “very dangerous road to go down”.
After hitting the highest level this century on Tuesday, the cost of long term UK government borrowing has now hit a fresh 27-year high.
The interest rate demanded by investors on the state’s long-dated borrowing (30-year bonds) rose to just below 5.75%, surpassing the 5.72% peak reached on Tuesday, pushing it to a high not seen since May 1998.
It comes as the government auctioned off these long-term loans on Tuesday and was forced to pay a premium to do so.
Issuing bonds is a routine way states raise money.
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As well as meaning the state has to pay more to borrow money, high interest rates on debt can signify reduced investor confidence in the ability of the UK to pay back these loans.
As the trading session continued, the interest rates on long-term government bonds, known as gilt yields, fell back to just above 5.66%, not enough to erase two days of rises.
The benchmark for state borrowing costs, the interest rate on 10-year bonds, also saw rises. The yield rose above 4.8% for the first time since January, before slightly falling back
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Why did UK debt just get more expensive?
The spiked borrowing cost also continued to cause a weakening in the pound.
After an initial fall to a month-long low against the dollar, one pound again buys $1.34.
It means sterling goes less far in dollars than before the latest peak in interest rates on government bonds. On Monday, sterling could buy $1.35.
Sterling dropped to equal €1.14 before easing up to €1.15. Just a few months earlier, a pound could buy €1.19 before Donald Trump’s April country-specific tariff announcements.
So why has this happened?
Government borrowing costs have been rising across the world amid a sell-off in bonds – which prompts investors to look for a higher return to hold them.
High inflation and national debts have increased concern about whether states can pay back the money.
Japan’s long-term borrowing cost hit a record high, while the yield on the US’s benchmark 10-year bond hit the 5% mark for the first time since July.
UK bond yields tend to follow the US.
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Key to easing UK borrowing costs was the announcement of the date of the budget on Wednesday morning.
UK public finances had been a worry for markets as Chancellor Rachel Reeves struggles to stick to her fiscal rules to bring down the debt and balance the budget.
Disquiet around comparatively low growth in the UK economy also played a role.
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