Bank of England cuts interest rates from 16-year high: what’s next?

Rate cuts: The Bank of England on Thursday (BoE) reduced interest rates to 5.00 per cent from 5.25 per cent, marking the first rate cut since March 2020. The decision, made by a narrow 5-4 vote from the Monetary Policy Committee, reflects the bank's cautious approach amid ongoing inflationary pressures.

Governor Bailey Emphasises Caution

BoE Governor Andrew Bailey emphasised the need for careful consideration in future rate decisions. "We need to ensure inflation remains low and avoid cutting rates too quickly or excessively," Bailey stated. This sentiment underscores the BoE's strategy to balance inflation control with economic stability.

Market Reaction and Economic Impact

Following the rate cut, the British pound showed little change, and bond yields slightly declined. Neil Birrell, Chief Investment Officer at Premier Miton Investors, remarked on the significance of the rate cut, noting the BoE's shift from a focus on inflation while maintaining caution regarding further reductions.

Economic Outlook and Inflation Projections

The BoE anticipates a rise in headline inflation to 2.75 per cent in the final quarter of 2024, driven by the fading effects of last year's energy price drops. However, the central bank expects inflation to return to its 2 per cent target by early 2026. Current inflation rates are lower than in the eurozone and the US, where the Federal Reserve has recently kept rates steady with hints of a potential cut in September.

Focus on Medium-Term Inflation Drivers

The BoE remains attentive to medium-term inflation drivers such as services prices, wage growth, and labor market conditions. Despite recent data showing higher-than-expected services inflation and persistent wage growth, the bank attributes these to "volatile components" and regulated prices influenced by previous high CPI readings.

Economic Growth and Future Rate Cuts
The BoE has revised its economic growth forecast upward to 1.25 per cent for this year, reflecting stronger-than-expected growth in the first half of 2024. Unemployment is projected to rise slightly as high interest rates impact economic growth. Financial markets had anticipated two additional quarter-point cuts by the end of the year, with rates expected to fall to about 3.7 per cent by the end of 2026.

Bond Sales and Market Impact
In its August report, the BoE maintained that its bond sales, which have been ongoing at a rate of £100 billion annually since 2009, had a limited impact on the gilt market. The bank estimated that these sales contributed modestly to a rise in 10-year gilt yields between February 2022 and June 2024. The BoE will reassess its bond-selling strategy in the coming months based on future market conditions.