BoE takes bold step to cut rates from 16-year high

London — The Bank of England (BoE) cut interest rates from a 16-year high on Thursday after a narrow vote in favour from policymakers divided over whether inflation pressures had eased sufficiently, which initially dented the pound.

Thursday’s decision was in line with the forecast in a Reuters poll of economists, though financial markets had expected a just more than 60% chance of a cut.

Governor Andrew Bailey — who led the 5-4 decision to lower rates by 0.25% to 5% — said the BoE’s monetary policy committee would move cautiously.

“We need to make sure inflation stays low, and be careful not to cut interest rates too quickly or by too much,” he said in a statement alongside the decision.

The FTSE 250 midcap index gained 0.3%, having hit its highest in more than two years. The blue-chip index pared gains, trading unchanged on the day.

Sterling fell to a session low of $1.2752 immediately after the decision, before reversing some of those losses to trade at $1.2787, down 0.54% on the day. It also pared some of its losses against the euro, which was up 0.23% at 84.39p off a session high of 84.57.

Benchmark 10-year gilt yields were last down 3.9 basis points (bps) on the day at 3.936%, unchanged compared with before the decision. Two-year gilt yields, which are more sensitive to shifts in monetary policy, were down 5 bps at 3.762%, about 15-month lows.

Laura Foll, UK equities manager at Janus Henderson in London. said: “The market was struggling to price ahead this decision because of the absence of smoke signals from Threadneedle Street during the election campaign. But there was a growing consensus in the City over the past couple of days that a cut was coming.

She said the BoE was still being cautious. “It was a close decision and the message is clear — don’t expect rate cuts at every meeting. But peak interest rates are, for now, behind us. And that might be sufficient to nudge consumers sitting on savings to stop postponing those big decisions on house moves, renovations and big-ticket spending.”

Harry Richards, Portfolio Manager for fixed income at Jupiter Asset Management, said the central bank’s decision to cut rates was justified. “The economy has evolved to such an extent that the level of extreme monetary policy was simply no longer required and, instead, dialling back the degree of restrictiveness makes ample sense. In our view, the BoE should loosen policy much more aggressively as we move into 2025 so as to avoid doing irreparable harm to the labour market and risk sparking the hard landing concerns once more.

“On the more positive side, the election result has delivered an air of relative political stability to the UK, which we believe may entice international investors to look favourably on UK fixed income markets. Importantly, however, the new government’s recent acknowledgment that taxes will need to rise is likely to act as a further brake on economic growth, increasing the pressure on the BoE to lower rates in the medium term.”

Philip Shaw, chief economist at Investec, said the cut indicated that the monetary policy committee was relaxed about “inflation persistence”.

“The various signs of loosening in the labour market appear to be a big factor in the decision today, and that’s outweighed the recent stuff on services inflation, which held at 5.7% in June.”

‘Steady quarterly pace’

Colin Asher, economist at Mizuho, expected the next rate cut to happen in November. “If you look at the headlines that Bailey produced: caution on cutting too quickly or by too much, it implies to me that they’re looking at a steady quarterly pace of reductions. So I would probably expect the next cut to come in November, assuming that the macroeconomic developments unfold as they expect.

“Generally speaking, I would expect sterling to gradually strengthen. I think you might be able to term this a hawkish cut, as in, you have guidance from Bailey suggesting not to go too far or too fast. And then in contrast from [chair Jerome] Powell, you have the Federal Reserve looking reasonably dovish and, to me, that suggests upside for sterling in the medium term.”

Daniele Antonucci, chief investment officer at Quintet Private Bank in Luxembourg, said that keeping rates too high for too long would have led to “unwarranted economic weakness”, resulting in undershooting the central bank’s inflation mandate to the downside.

“Even though it makes sense to proceed at a moderate pace, beginning to soften the degree of monetary tightening looks like the most sensible approach. We’ve increased our exposure to short-dated gilts. This is because short-dated bonds are most sensitive to central bank rate changes.”

Dean Turner, chief eurozone and UK economist at UBS Global Wealth Management in London, said: “In our view, further easing is likely in the coming months as the disinflationary trends continue into the new year. The prospect of lower interest rates should continue to favour taking exposure to high-quality corporate and government bonds.

“As for sterling, it has struggled to build on its recent gains, but we see potential for upward momentum to resume when the Fed joins the interest-cutting cycle, which we expect it to do when it meets in September.”

Jeremy Batstone-Carr, strategist at Raymond James, said the UK’s economic performance in recent months had improved, which had provided a boost for the newly installed Labour government.

“However, real interest rates remain high and there has been a stronger-than-expected strengthening in demand over potential supply constraints, notably in the labour market. Despite this, the committee has taken a leap of faith in cutting rates, hoping to stimulate consumers with lower borrowing costs and increased spending power.”

Neil Birrell, chief investment officer at Premier Miton Investors in London, said: “Falling UK interest rates have arrived at last. The Bank of England has moved from worrying about inflation to worrying about economic growth, although they are bound to be cautious about further cuts and can’t lead the bond market to expect too much too soon.

“But, it is an important move, with only the US not joining the global rate cutting party to date. We could see financial markets further reflect the turn in the cycle, at aggregate level, but probably more so within asset classes.”

Julius Bendikas, European head of economics and dynamic asset allocation at Mercer in London, said the rate cut was a surprise. “Having said that, we expect one to two more rate cuts in 2024 with more to come in 2025. The economy has normalised, so should the interest rates.”

Michael Brown, market strategist at Pepperstone in London, said: “Looking ahead, a relatively gradual quarterly pace of cuts seems most plausible for the [BoE], with further normalisation likely to coincide with meetings at which a monetary policy report is published, leaving the base case as just one more cut this year, at the November meeting. Such a pace would be broadly in line with that priced by markets, and that likely to be delivered by other G10 central banks, potentially limiting any prolonged sterling downside on the back of today’s decision.”

Reuters